In Cigna Health & Life Insurance Company v. Audax Health Solutions, Inc. (Del. Ch. November 26, 2014), the Delaware Court of Chancery invalidated two buyer-imposed requirements that are frequently found in private company mergers, specifically the conditioning of payment of merger consideration on a release and certain aspects of post-closing stockholder indemnity obligations. The case arose from United Health Group’s acquisition of Audax Health by merger. As part of the merger, the former stockholders of Audax Health were required, as a condition to receipt of their portion of the merger consideration, to sign a letter of transmittal that contained a release and an acknowledgment of the indemnification provisions of the merger agreement. Cigna, one of the former stockholders of Audax Health, refused to sign the release or acknowledge the indemnification obligations. In a relatively limited ruling, the Court, first, invalidated the requirement that Cigna enter into a release as a condition to its receipt of merger consideration. The Court found that the release requirement lacked consideration. While noting that the release in the context of the transaction was very broadly written, the Court based its holding on the fact that the release was an after-imposed condition and invalidated it principally because the merger agreement, itself, did not specifically reference the release as a condition of payment. The Court, next, invalidated the requirement in the merger agreement that Cigna acknowledge the indemnification obligations. The Court’s holding with respect to the indemnity acknowledgment was also limited and based on the fact that the indemnification provision exposed Cigna to a clawback of its entire merger consideration for breaches of certain fundamental representations for an indefinite period of time. The Court did not decide whether a more limited formulation would be permissible. The transaction did not include an escrow provision and the Court acknowledged that escrows are commonly used in acquisitions and that the ruling did not invalidate the use of escrows of a portion of merger consideration.
Impact of the opinion on private M&A practice
Due to the limited nature of the ruling, we do not expect the decision to materially impact private company mergers and acquisitions practice. Transaction planners, however, should be aware of the opinion and should be cognizant that the opinion may influence market practice in the following areas:
Joinders; post-closing indemnification obligations and purchase price adjustments. The most difficult aspect of the Cigna decision to assess is its impact on structuring post-closing purchase price adjustments and post-closing indemnification obligations. We do not believe that the decision should be read to necessarily require the separate agreement of individual stockholders for them to be bound by escrows or working capital or similar price adjustment mechanisms in all cases. However, the decision does call into question any post-closing indemnification provision in a merger agreement that purports to bind non-signatories to indemnification obligations that are uncapped (or that are capped at a stockholder’s pro rata share of the full merger consideration), whether or not limited to fundamental representations, for an indefinite period of time. At the same time, the decision suggests that post-closing indemnification obligations that survive for a fixed term of a reasonable duration are generally permissible. Although the Court did not draw a definitive line, it did specifically say that its decision to allow Cigna to tender its shares for merger consideration free of indemnification obligations only applied to those aspects of the indemnification obligations that were not subject to a monetary cap and a time limit of 36 months or less. In the future, we expect that transaction planners may consider mitigating enforceability risk by requiring written joinder or other agreements from a supermajority (such as 90%+) of the stockholders of the target, deferring (or holding back a larger portion of the consideration) or otherwise taking steps to make the merger agreement look more like a stock purchase agreement (see above). These mitigation techniques were used actively in private mergers and acquisitions practice prior to the ruling and we would expect them to continue to be used, perhaps with greater emphasis, after the ruling.
Stockholder releases. We do not expect the Court’s decision regarding stockholder releases to dramatically impact practice because many practitioners were already somewhat skeptical about the enforceability of releases in letters of transmittal. To the extent that receipt of releases are critical in particular transactions, the merger agreement should clearly indicate that the delivery of releases from a specified list or category of stockholders will be a condition to closing and will be a requirement for the payment of the merger consideration. As an additional “fix,” however, and to improve the likelihood that a court would approve a release requirement in any particular instance, transaction planners should also consider narrowing the scope of the requested stockholder release by, perhaps, limiting the release to cover only stockholder-related claims or paying separate consideration for the release.
Transactions structured as stock purchases instead of mergers. We anticipate that some more risk adverse buyers will read the opinion broadly and insist on structuring deals as stock purchase transactions instead of mergers, and thereby requiring 100% stockholder unanimity before agreeing to move forward with a transaction. We do not think this is a practical approach in many transactions with numerous stockholders or with former employees/founders as stockholders and would not generally recommend that our buy side clients take this approach. To the extent that a trend towards stock purchases emerges from this decision, we would hope (and expect) that it would be limited, and that a relatively few number of buyers will adopt it as a uniform requirement. The costs to transaction participants—in terms of lost flexibility in transaction planning and the potential for one or a few minority stockholders to hold the others hostage—seem to us to be too great otherwise.
Impact of the opinion on corporate venture
One less talked about aspect of the Cigna case may be the impact that the case has on corporate venture investment. In this case, Cigna’s assessment of the release it was asked to sign was undoubtedly colored by the fact that the acquirer in the transaction, an affiliate of United Health Group, was one of Cigna’s biggest competitors. We will be curious to see if the facts of the case have the effect of discouraging promising companies with other alternatives from raising private capital from strategic investors in the future.