Private Equity

The recent decision, by Vice-Chancellor Laster in the Delaware Court of Chancery, in Fox v. CDX Holdings, Inc. is another reminder that, when attempting to bind non-signatories to the post-closing indemnification and escrow provisions of a private company merger agreement, careful compliance not only with the merger statute but also with other relevant contractual rights applicable to shareholders and option holders must be the watchword.  In this case, the holders of options who had 8% of their option cancellation consideration withheld in an indemnification escrow account, just like the stockholders, successfully sued to have that amount paid over to them by the target.  As noted by Vice Chancellor Laster, although 251(b) of the Delaware General Corporation law permits a merger agreement to “convert shares into the right to receive consideration that incorporates the outcome of an indemnification mechanism, … [thereby] bind[ing] non-signatory stockholders to post-closing adjustments, including escrow arrangements, when stockholders otherwise would not be bound under basic principles of contract and agency law, …[o]ptions are not shares, and option holders are not stockholders.” Instead, “[t]he rights and obligations of the parties to the option are governed by the terms of their contract,” which is the Plan itself.  Here the Plan stated that in the event of a merger the option holders’ options could be cancelled, but that in such event they were entitled to receive the “difference between the Fair Market Value and the exercise price for all shares of Common Stock subject to exercise.”

And, as a reminder, don’t over read what is permitted by 251(b), even as to stockholders, and remember last year’s Cigna decision that prohibited open-ended indemnification from being binding on non-signatories. The Fox case contains some important reminders that when the Plan says that the Board must determine Fair Market Value, you better have a record that they in fact did that as a board, not simply as members of management that were on the board and ultimately controlled the majority of the stock.  The Board still has to take the action as a board.

The court clearly indicated that the Plan could have been better drafted:  “The Plan could have been drafted differently, such as by providing that holders of options cancelled in connection with the merger would receive the same consideration received by holders of stock, less the exercise price. The Plan did not say that. The Plan said that holders of cancelled options would receive the difference between the Fair Market Value of the underlying shares and the exercise price for their options.”