By Steve Quinlivan | July 25, 2021
In Houseman et al v. Sagerman et al the Plaintiffs challenged the enforceability of the indemnification provisions in a merger agreement amongst other things. The Merger Agreement provided for an indemnification escrow. A subset of the Shareholders collectively owning over 72% of target's shares (the "Owners") were parties to and signed the Merger Agreement. The Owners agreed to provide certain indemnification for amounts in excess of the escrow or after the escrow was depleted. However, Plaintiffs did not execute the Merger Agreement.
Plaintiffs argued that indemnification from the escrow was illegal and unenforceable. They cited to Cigna Health & Life Insurance Company v. Audax Health Solutions as support for the proposition that, as stockholders who did not consent to the merger, they cannot be bound by the indemnification obligations. In Cigna, the Court concluded that the indemnification obligation imposed by the merger agreement was void and unenforceable because it violated 8 Del. C. § 251. The post-closing adjustments permitted by the merger agreement as indemnification were not limited in amount or in duration. Accordingly, the stockholders would never have been able to know the exact value of the merger consideration and the merger agreement failed to set forth "the cash, property, rights or securities of any other corporation or entity which the holders of such shares are to receive" as required by § 251(b)(5). Thus, Cigna did not reach the more general question whether post-closing price adjustments can bind non-consenting stockholders.
In this case the Merger Agreement explicitly limited the Plaintiffs' indemnification obligation to the escrow, and, with the exception of certain fundamental representations and warranties guaranteed solely by the Owners, the obligations did not survive indefinitely. The terms of the indemnification rights were both made explicit and limited in duration. Therefore, the Court concluded Cigna was inapplicable.
The next question before the Court was whether the Shareholder Representative could act on behalf of all of the shareholders or only the Owners that signed the Merger Agreement. The Court found that even though the Shareholders' Representative was appointed by the Owners, and not all shareholders, that did not limit the ability of the Shareholder Representative to act on behalf of the other shareholders. The Merger Agreement provided that "[t]he Owners hereby appoint Thomas D. Whittington (the "Shareholders' Representative") as their attorney-in-fact with full power . . . to perform any and all acts necessary or appropriate in connection with the Agreement." The Merger Agreement further provided that the actions of the Shareholders' Representative "shall be binding upon all of the Owners and Shareholders."
In the view of the Court, the actions of a stockholders' representative are generally binding on all stockholders. Looking to prior precedent, the Court noted that all Section 251 of the DGCL required was for the representative to be designated as the individual who would follow the procedures and make or participate in the determinations called for by the Merger Agreement. In this case the Merger Agreement designated the Shareholders' Representative to carry out the actions contemplated by that Agreement. Therefore, the Shareholders, whether signatories or not, were bound by the actions and determinations of the Shareholders' Representative to the extent they are in accordance with the Merger Agreement's terms.
Finally, the Plaintiffs argued that Delaware law prohibited the contractual modification of a shareholders' representative's fiduciary duties and, therefore, that the Merger Agreement's grant of "sole and absolute discretion" to the Shareholder Representative was impermissible.
According to the Court, a shareholders' representative, as attorney-in-fact for the selling shareholders, generally assumes the obligations of a fiduciary. However, the duties of an attorney-in-fact, like those of some other types of fiduciaries, may be modified by contract. The shareholders' representative is generally not a corporate fiduciary. Rather, a shareholders' representative is an agent of the shareholders whose powers and responsibilities are circumscribed by contract.
The Court reasoned that the Merger Agreement explicitly rejected the Shareholders' Representative's common law duties, by providing that "[t]he Shareholders' Representative shall not have any duties or responsibilities except those expressly set forth in this Agreement." The Shareholders' Representative's duties were, broadly, "to perform any and all acts necessary or appropriate in connection with this Agreement," including "doing any and all things and taking any and all action that the Shareholders' Representative, in such Person's sole and absolute discretion, may consider necessary, proper or convenient in connection with or to carry out the activities . . . contemplated by this Agreement."
The standard in the Merger Agreement, according to the Court, was equivalent to a duty of subjective good faith. The discretion of the Shareholder's Representative was cabined by the determination that a contemplated action is "necessary, proper or convenient" in connection with carrying out the Merger Agreement on behalf of the Shareholders. If the Shareholder Representative acted without such a determination, the Shareholder Representative would have breached a duty.
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