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Winshall v. Viacom Internationa, Inc., C.A. No. 6074-CS (Del. Ch. Nov. 11, 2011) (Strine, C.)

November 10, 2011

In this opinion, the Court of Chancery granted the defendants’ motion to dismiss for failure to state a claim upon which relief can be granted, rejecting a claim by a stockholder representative that the parties to a merger agreement breached the implied covenant of good faith and fair dealing by failing to take certain actions after the closing of the merger that would have the effect of increasing the earn-out payments due to the former stockholders of the target corporation. The plaintiff stockholder representative alleged that the defendant corporations breached the implied covenant of good faith and fair dealing by renegotiating a contract with a third party distributor for a distribution fee discount in exchange for the distribution rights to future products, where the distribution fee discount would not apply until after the stockholders’ earn-out period expired. The Court held that the plaintiff stockholders had no expectancy interest in products released after the expiration of the earn-out period, and therefore, the corporations did not breach the implied covenant by pushing off the distribution fee discount until after the expiration of the earn-out period.

The dispute arises from the merger agreement between Viacom International, Inc. (“Viacom”) and Harmonix Music Systems, Inc. (“Harmonix”), which contained a provision granting a contingent right to Harmonix stockholders to receive uncapped earn-out payments based on Harmonix’s financial performance in 2007 and 2008 (the “Merger Agreement”). One year after the merger closed, Harmonix released a video game, Rock Band, which was an instant success. Electronic Arts, Inc. (“EA”) had a distribution agreement in place with Harmonix for the distribution of Rock Band through 2010 (the “Original EA Agreement”), but, following the success of Rock Band, EA wanted to renegotiate the contract for broader rights to future games. Viacom, Harmonix, and EA agreed to amend the Original EA Agreement to allow EA broader distribution rights to future sequels and to distribute Rock Band for the same fees in 2008 in exchange for reduced distribution fees after 2008 and the payment of certain royalties in the following years (the “Amended EA Agreement”).

Plaintiff Walter A. Winshall (“Winshall”), the Harmonix stockholder representative, filed suit claiming that Viacom and Harmonix breached the implied covenant of good faith and fair dealing inherent in the Merger Agreement by intentionally deferring the distribution discount until after the expiration of the earn-out period. If the distribution discount had applied in 2008, the stockholders would have received a higher earn-out payment for that year. Defendants moved to dismiss the suit for failure to state a claim upon which relief can be granted. In determining whether to dismiss the claim, the Court first stated that the pleading standards governing motions to dismiss are minimal. Despite that low pleading burden, the Court found Winshall’s Complaint did not assert an actionable claim. The Court rejected Winshall’s argument that Viacom and Harmonix had a duty to renegotiate the Original EA Agreement to increase the amount of the stockholders’ earn-out payments. The Court articulated two factors that are fatal to the plaintiff’s argument: (1) Viacom and Harmonix did not increase the 2008 fees beyond what was expected under the Original EA Agreement, and (2) the benefits that Viacom and Harmonix received under the Amended EA Agreement were offered in exchange for product sales after 2008 – product sales which the Harmonix stockholders had no expectancy interest in. The Court observed that, according to Winshall’s argument, the defendants not only had a duty not to harm Harmonix business in a way that would reduce the earn-out payments, but also to “do everything it could to increase the earn-out payments.” The Court rejected this reading of the implied covenant of good faith and fair dealing.

The Court distinguished this case from a case where a company deliberately delayed entering into contracts in order to avoid its earn-out obligations. Here, the plaintiff stockholders had no legitimate expectation that, upon a renegotiation with EA, Viacom and Harmonix would choose a structure that increased the amount of the already unlimited earn-out payments to the stockholders. Furthermore, the plaintiff stockholders had no expectancy interest in the sequels that would not be released during the earn-out period, which the Amended EA Agreement centered around. Consistent with the above analysis, the Court granted the defendants’ motion to dismiss for failure to state a claim upon which relief can be granted.

The full opinion is available here