Private Equity

In what appears to be the last decision related to the Twitter/Musk saga, Crispo v. Musk, 2023 WL 7154477 (Del. Ch. Oct. 31, 2023), Chancellor McCormick cast significant doubt upon the ability of a target company to recover damages measured by the “lost stockholder premium” that was bargained for as part of the merger agreement. Although this issue had been out there as a theoretical problem ever since the Second Circuit’s decision in Consolidated Edison, Inc. v. Northeast Utilities, 426 F.3d 524 (2d Cir. 2005) (almost universally referred to as “Con Ed”), most practitioners believed Delaware courts would likely view damages measured by the lost stockholder premium as, at least in part, recoverable by a target company when an acquirer wrongly terminated the merger agreement and the expected conversion of the target’s stock into the agreed-upon merger consideration did not occur. But that belief now appears to have been unjustified.

To cut to the chase, here is what Chancellor McCormick said concerning the ability of the target company to bargain for recovery of the lost stockholder premium as part of the measure of its damages in the event of the acquirer’s wrongful failure to close a merger with the target:

A target company has no right or expectation to receive merger consideration, including the premium, under agreements that operate like the Merger Agreement. The Merger Agreement provides that at the “Effective Time” (defined as the time when the parties file the certificate of merger with the Secretary of State), stock will be converted into the right to receive merger consideration. Under this framework, no stock or cash passes to or through the target. Rather, merger consideration is paid directly to the stockholders. Accordingly, only a stockholder expects to receive payment of a premium under the Merger Agreement.

Where a target company has no entitlement to a premium in the event the deal is consummated, it has no entitlement to lost-premium damages in the event of a busted deal. Accordingly, a provision purporting to define a target company’s damages to include lost-premium damages cannot be enforced by the target company. To the extent that a damages-definition provision purports to define lost-premium damages as exclusive to the target, therefore, it is unenforceable.¹

It might be tempting to dismiss Chancellor McCormick’s remarks on the target’s ability to bargain for recovery of the lost stockholder premium as dicta given that the decision was not about the target’s right to these damages, but instead about whether the plaintiff stockholder was entitled to a mootness fee based on the plaintiff claiming some credit for causing Mr. Musk’s acquisition vehicle to close the deal. But I think that is a mistake. The determination of whether the plaintiff stockholder was entitled to a mootness fee turned in part upon whether the plaintiff stockholder’s claim was meritorious when filed, and that turned on whether the plaintiff stockholder was a third party beneficiary of the Merger Agreement at the time the claim was originally filed. Although the Merger Agreement’s “no third party beneficiary” provision clearly denied general third party beneficiary status to stockholders, except in limited circumstance not applicable here, Chancellor McCormick posited that by defining damages to include lost stockholder premium (at least in the context of a “willful breach”), the parties may have intended to confer specific third party beneficiary status upon stockholders in the limited circumstance where the target was no longer pursuing specific performance and damages were at play. But even with that interpretation, the plaintiff stockholder here would not have been a third party beneficiary when its claim was filed because the target was pursuing specific performance directly against the acquirer. Accordingly, no mootness fee.

But for M&A lawyers, the important point is that in arriving at an interpretation of the lost stockholder premium provision that might provide third party beneficiary rights to stockholders in the limited circumstance where the target was not pursuing specific performance, Chancellor McCormick noted that, in the absence of such an interpretation, the provision was effectively a nullity. Why? Because a provision that defines damages of a party to include losses that it did not incur, would be considered a penalty clause and unenforceable.² And as noted, Chancellor McCormick’s view is that these damages are never incurred by the target, but only by the stockholders. Accordingly, a provision purporting to define the target’s “damages to include lost-premium is only enforceable if it grants stockholders third-party beneficiary status.”

When Con Ed was decided in 2005 by the Second Circuit it created quite a stir in the M&A deal community. Con Ed held that, in the absence of third party beneficiary rights being granted to stockholders in a merger agreement, there was no right to recover an agreed stockholder premium as part of the merger consideration in a busted merger. Accordingly, the target was essentially limited to its out of pocket expenses in pursuing the transaction.

Con Ed was decided under New York law, and there was a fair amount of confidence among M&A lawyers that Delaware courts would not follow Con Ed’s reasoning. Indeed, then Vice Chancellor Strine was reported as having said as much.³ But, of course, no one could know for sure what Delaware courts may do. So, while many merger agreements continued to remain silent on this issue, some deal professionals began adding Con Ed provisions to their merger agreements. These provisions attempted to deal with the Con Ed problem by one of three different approaches: (1) granting express third party beneficiary rights to the target’s stockholders to sue for the lost stockholder premium in a wrongly busted deal; (2) expressly designating the target as having the right to sue for the lost stockholder premium, as effectively the stockholders’ agent; or (3) defining the target’s recoverable damages in the event of the acquirer’s wrongful failure to consummate the merger as including the stockholder’s lost premium. The first approach was rarely used, as it presents real problems for the parties by introducing third parties to any potential amendments to the merger agreement in the event there are changed circumstances (or the ability of the board to settle litigation arising from the merger). The second approach, according to Chancellor McCormick, was arguably invalid as it effectively rested upon the target appointing itself as agent for the stockholders, without the stockholders agreeing to that appointment.⁴ The last approach proved to be the most popular and that’s the approach that was used in the Twitter/Musk merger agreement; an approach that Chancellor McCormick effectively held invalid to the extent it did not grant third party beneficiary rights to stockholders to recover those agreed damages.

If meaningful damages are not available to the target, that puts a lot of pressure on specific performance as the only remedy standing in the way of an acquirer converting a merger agreement into a mere option. And to be sure specific performance is many times the preferred remedy. But specific performance may not always be practical or appropriate. What if the acquirer breached its covenants related to financing and the financing required to consummate the merger is no longer available? How do you force the closing; and without meaningful damages, what keeps the acquirer focused on using its best efforts to fulfill all conditions to the consummation of the merger, without which the merger cannot occur.

Chancellor McCormick appears to clearly view the specific performance remedy as vested exclusively in the target company and not in the stockholders, absent an explicit grant of third party beneficiary rights.  But interestingly enough, two academics posited that specific performance was not in fact a valid remedy for a target company in a merger context, largely based upon Con Ed-like arguments. When Twitter was pursuing specific performance before the deal ultimately closed, Professor Todd M. Henderson (and his co-author J.B. Heaton) opined that specific performance was unlikely to be ordered by a Delaware court.⁵ Their basic argument was that Twitter was effectively unharmed by any default by Mr. Musk and his acquisition vehicle. Twitter would be the same company, with the same assets, whether the merger occurs or not. Instead Twitter’s stockholders are the ones with something to lose, because consummation of the merger entitles them to payment for their stock at a premium to current market value. But the stockholders are not only not parties to the merger agreement, they are, as in most merger agreements, specifically disclaimed as beneficiaries of the merger agreement, except in the case where the merger actually closes and they become entitled to the cash consideration provided in the plan of merger (but they are not beneficiaries for purposes of enforcing remedies against a potentially defaulting acquirer). Thus, according to Heaton/Henderson:

To order specific performance of the deal is to order contract parties to perform so that non-parties to the contract (the Twitter, Inc. shareholders) who were expressly disavowed as third-party beneficiaries for remedy purposes can receive payment for cancelled shares, … . … Only by ignoring the legal distinction between Twitter, Inc., the corporation, and Twitter, Inc.’s pre-merger shareholders could specific performance make sense.⁶

Heaton/Henderson go on to suggest that what a target company, like Twitter, does when it enters into a merger agreement is act “as a commission-free broker of a deal where current Twitter, Inc. shareholders agree to have their shares cancelled in return for a payment and Musk’s parent holding company agrees to make that payment in return for ownership of Twitter’s (one) new share.”⁷

A target company entering into a cash merger is certainly not brokering a deal between the acquirer and the stockholders for the stockholders to sell their stock to the acquirer for a cash price. Instead, the target company is acting as a person legally distinct from its stockholders in entering into a transaction that statutorily converts its existing stock into the right to receive the per share cash consideration bargained for in the plan of merger. Corporations exist to deliver value to stockholders, and the plan of merger was the unique means to accomplish that objective. Having bargained for a transaction that statutorily converts stock into the right to receive per share cash consideration, a breach of that agreement deprives the target of its ability to deliver to its stockholders the unique, bargained-for value that transaction was designed by the target to deliver. In a statutory merger, it is the target that would be enforcing the bargain it made for itself to deliver value to its stockholders, not the target acting as a broker to enforce a theoretical bargain made by the acquirer with the target’s stockholders that is only mediated through the target.

Chancellor McCormick appears to clearly reject the Heaton/Henderson-type of arguments respecting the target company’s right to pursue specific performance, and as noted by at least one Delaware court “one of the consequences of the limited liability that shareholders enjoy is that the law treats corporations as legal persons not simply agents for shareholders.”⁸ Indeed, in an earlier decision rejecting this same plaintiff’s effort to enforce specific performance directly, Chancellor McCormick reinforced the concept that it is the target company that is bargaining for and obtaining the benefits of the merger consideration:

In the sale context, “[t]he directors’ role change[s] from defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company.” When exercising its fiduciary duties to maximize stockholder value in that context, a board needs the contracting freedoms available to other contracting parties, including the ability to control any litigation to enforce the agreement and to extract value by eliminating the risk that a multitude of individual stockholders might seek to sue a buyer directly under the merger agreement.⁹

But why is the damages remedy any different? If the acquirer wrongly refuses to consummate the merger, is the target company really the same as it was before that breach (other than its out of pocket expenses)? Isn’t the lost stockholder premium simply the control premium that only the target company, acting through its board, has the power to deliver through the merger? And, unless and until the target company’s stock has been converted into the right to receive the merger consideration, isn’t it the target company itself that has been damaged by the buyer’s failure to consummate the merger and deliver the bargained for control premium, at least to the extent that a subsequent auction is unlikely to reproduce that same control premium?¹⁰ Couldn’t it actually be said that the stockholders’ losses in a failed merger are, as our English colleagues would say, merely “reflective” of the damages that are sustained by the target company itself?¹¹

It is important to note that Chancellor McCormick did not have an opportunity to consider arguments by a target company actually seeking to enforce the bargained-for stockholder premium as a potential measure of the damages actually sustained by the target company because of the actual issue being decided in this case. Nonetheless, the Delaware Court of Chancery has now spoken to the Con Ed issue, and has sided with Con Ed. Practitioners may need to go back to the drawing board to consider new approaches to the Con Ed problem.

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1 Crispo v. Musk, 2023 WL 7154477, at *12 (Del. Ch. Oct. 31, 2023).

2 For prior blog posts concerning the common law’s prohibition on penalties see Glenn West, When “Liquidated Damages” Are Not—The Common Law’s Abhorrence of Penalties and What You May or May Not Be Able to Do About It, Weil’s Global Private Equity Watch, December 22, 2020; Glenn West, Agreed Damages or Unenforceable Penalties—Drafting to Affirm the Former and Avoid the Latter, Weil’s Global Private Equity Watch, July 10, 2017; Glenn West, Freedom of Contract?—An Agreed Damages Clause May Not Actually Be Agreed, Weil’s Global Private Equity Watch, September 6, 2016.

3 When asked about the impact of the Con Ed decision at the Securities Regulation Institute Seminar at the Northwestern University School of Law (Jan. 24, 2008) (“M&A Trends and Developments”), then Vice Chancellor Strine was reported to have said:

I don’t understand what the purpose of a board of directors negotiating a cash-out merger for its stockholders is if it is not . . . to obtain, as an instrument of the stockholders, the profits of the contract. And I always thought the . . . third-party beneficiary [provision] was not designed to deprive the corporation of remedies pursued in good faith by the directors on behalf of the stockholders, but designed to deal with the cacophony that could arise with individual shareholders trying to enforce a contractual right. . . . I really don’t have difficulty conceptualizing that the contract was negotiated for the benefit of the stockholders as it must be by the directors . . . that in order to . . . honor the expectations of the parties you have to recognize that was its purpose and to allow the board of directors as an instrument for those stockholders to collect.

Ryan D. Thomas & Russell E. Stair, Revisiting Consolidated Edison–A Second Look At The Case That Has Many Questioning Traditional Assumptions Regarding The Availability Of Shareholder Damages In Public Company Mergers, 64 Bus. Law. 329, 342 n. 70 (2009).

4 Chancellor McCormick suggested that there may be a solution to this unauthorized agency by the target company. See Crispo v. Musk, 2023 WL 7154477, at *10 n.86 (“Perhaps corporate law could supply a solution here. Would a charter provision designating the company as the stockholders’ agent for the purpose of recovering lost-premium damages after failed sale achieve the result intended by the second approach? See 8 Del. C. § 102(b)(1) (permitting ‘any provision creating, defining, limiting and regulating the powers of the corporation, the directors, and the stockholders, or any class of the stockholders, or the governing body, members, or any class or group of members of a nonstock corporation; if such provisions are not contrary to the laws of this State’)”). This solution would need to be approached cautiously given that the appointment of the company as the stockholders’ agent presumably means that the stockholders are the company’s principal under agency rules. And a principal can be held liable for the acts of its agent to the extent the agent is acting within the scope of that agency. See REST 3d AGEN § 7.04 (“A principal is subject to liability to a third party harmed by an agent’s conduct when the agent’s conduct is within the scope of the agent’s actual authority or ratified by the principal; and (1) the agent’s conduct is tortious, or (2) the agent’s conduct, if that of the principal, would subject the principal to tort liability.”). Given the limited agency proposed here that may be a minor risk, but one to consider nonetheless.

5 J.B. Heaton & Todd Henderson, JB Heaton and Todd Henderson Respond: They Think Twitter’s Lawsuit is a Loser, July 18, 2022, ProfessorBainbringe.com; see also, J.B. Heaton & Todd Henderson, Twitter’s Argument Reflects Del. Chancery Stance On Boards, Law360, September 15, 2022, 4:52 PM EDT, (“to order specific performance of the merger is to order a party to the contract — the acquirer — to perform so that nonparties to the contract — the corporation’s legally distinct shareholders — can receive payment for canceled shares, while the nonbreaching party, the target corporation, is left essentially uninjured.”).

6 Id.

7 Id.

8 Orban v. Field, 1993 WL 547187, at *9 (Del. Ch. Dec. 30, 1993), as quoted in Crispo v. Musk, 2023 WL 7154477, at *5 n.44.

9 Crispo v. Musk, 2022 WL 6693660, at *4 (Del. Ch. Oct. 11, 2022).

10. See IPB, Inc. v. Tyson Foods, Inc., 789 A.2d 14, 83 (Del Ch. 2001) (“the determination of a cash damages award will be very difficult in this case. And the amount of any award could be staggeringly large. No doubt the parties would haggle over huge valuation questions, which (Tyson no doubt would argue) must take into account the possibility of a further auction for IBP or other business developments. A damages award can, of course, be shaped; it simply will lack any pretense to precision.”).

11 See Sevilleja v. Marex Financial Ltd [2020] UKSC 31, at para. 39 (“a diminution in the value of a shareholding or in distributions to shareholders, which is merely the result of a loss suffered by the company in consequence of a wrong done to it by the defendant, is not in the eyes of the law damage which is separate and distinct from the damage suffered by the company…”).