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In Cigna Health and Life Ins. Co. v. Audax Health Solutions, Inc., C.A. No. 9405-VCP, 2014 WL 6784491 (Del. Ch. Nov. 26, 2014), the Delaware Court of Chancery held (a) that a release contained in a letter of transmittal that the target’s stockholders were required to sign in order to receive the merger consideration was unenforceable and (b) that the indemnification obligations in the merger agreement were invalid as to those target stockholders who did not agree to be subject to them.
The dispute in the case arose out of the acquisition by merger of Audax Health Solutions, Inc. by Optum Services, Inc., a subsidiary of UnitedHealth Group Inc. The plaintiff, Cigna Health and Life Insurance Co., was a stockholder of the target who also happened to be a competitor of the buyer.
As is common in a private company merger, the target’s board approved the merger and submitted it to the target’s stockholders for approval by written consent. The target’s stockholders approved the merger by delivering support agreements that included (a) their consent to the merger; (b) a release of any claims against the buyer and its affiliates; (c) an agreement to be bound by the terms of the merger agreement, including the indemnification obligations; and (d) the approval of the appointment of Shareholder Representative Services, LLC as the stockholder representative.
Cigna did not deliver a support agreement and did not otherwise vote in favor of the merger.
As is common, the target’s stockholders were to receive the merger consideration only after surrendering their shares and returning a signed letter of transmittal. The letter of transmittal required the stockholders to agree to the obligations included in the support agreement.
Cigna refused to sign the letter of transmittal. Consequently, the buyer refused to pay to Cigna its share of the merger consideration, and Cigna then sued the parties to the merger agreement and the stockholder representative.
The Short Story
In a motion for judgment on the pleadings, Cigna argued that: (a) the release contained in the letter of transmittal was unenforceable because it lacked consideration and (b) requiring it to agree to the obligations in the support agreement in order to receive the merger consideration was unenforceable because it was entitled to the merger consideration immediately upon cancellation of its shares in the merger. The court agreed (for the most part).
The court found that because the release (which did not appear at all in the merger agreement) was a new obligation that the defendants sought to impose on Cigna post-closing, and because no consideration was being provided to Cigna beyond the merger consideration (to which it became entitled when the merger was consummated), the release lacked consideration and was therefore unenforceable.
The Indemnification Obligations
The indemnification obligations in the merger agreement provided that the former target’s stockholders would be liable to the buyer for up to the pro rata amount of their merger consideration for breaches of the target’s representations and warranties. Although the merger agreement provided that indemnity claims for most of the representations and warranties would terminate following a specified survival period, the “fundamental representations” survived indefinitely and were not subject to a monetary cap.
Section 251(b)(5) of the DGCL requires that the merger agreement state the cash, property, rights or securities that target stockholders are to receive in exchange for their shares.
Because the indemnification obligations (at least with respect to the fundamental representations) in the Audax merger agreement were not subject to a monetary cap and were not limited in temporal duration, Cigna argued that the merger agreement violated Section 251(b)(5) because there was no point in time at which the merger consideration was firm and determinable.
The defendants countered that the indemnification obligation was no different than an escrow provision, which was widely understood to be permissible. The defendants further argued that finding the indemnification obligation to be invalid would endanger the enforceability of escrow agreements.
The court distinguished the indemnification obligation in the merger agreement from an escrow provision and found that the indemnification obligation did violate Section 251. The court held that the lack of a monetary cap and a temporal limitation on the indemnification obligation for breaches of fundamental representations was problematic. The court noted that “[p]ushing [d]efendants‘ economic equivalence argument to its logical conclusion, the analogous escrow structure would be a 100% indefinite escrow pursuant to which the merger consideration would be released only after the buyer determined it would never make a claim under the [m]erger [a]greement. Such a provision is hard to fathom.”
What About the Stockholder Representative?
The court did not make a determination regarding the validity of the appointment of the stockholder representative because Cigna only tangentially challenged the matter. However, the court did not note that "[t]he propriety of stockholder representatives
under the DGCL is the subject of active and ongoing debate."
The Cigna decision may change the structuring of private M&A deals and the negotiation of indemnification obligations. Unless a buyer is able to enter into a stock purchase agreement to which all of the target’s stockholders are a party, buyers will need to consider the Cigna decision and consider how best to structure a merger agreement in light of it.