Cigna Health and Life Ins. Co. v. Audax Health Sol’ns, Inc., C.A. No. 9405-VCP (Del. Ch. Nov. 26, 2014)
In this action seeking a declaratory judgment regarding the validity of certain provisions in a merger agreement and related contracts, the Court of Chancery granted in part plaintiff’s motion for judgment on the pleadings, holding that an attempt to extract a general release from stockholders before distributing merger consideration was invalid for lack of consideration. The Court also struck down an indemnification provision set forth in the merger agreement, which purported to render stockholders potentially liable for breach of the agreement’s representations and warranties, as void for violating Section 251 of the Delaware General Corporation Law (“DGCL”), but limited the scope of this holding.
In February 2014, defendant Optum Services, Inc. (“Optum”) acquired defendant Audax Health Solutions, Inc. (“Audax” and, together with Optum, “United”) by merger. The merger was approved by the written consent of over two-thirds of Audax’s stockholders. The governing Merger Agreement conditioned payment of merger consideration on a stockholder’s surrender of shares and its execution of a Letter of Transmittal.
Plaintiff Cigna Health and Life Insurance Co. (“Cigna”) challenged the Letter of Transmittal because it required Cigna to execute a Support Agreement that included the following three provisions: (1) a release of any claims against United; (2) an agreement that Cigna would be bound by the Merger Agreement, specifically including provisions indemnifying United for any breaches of representations and warranties; and (3) an agreement to appoint a stockholder representative. Cigna refused to execute the Support Agreement but demanded payment for its shares. Optum refused to pay, and Cigna brought suit challenging the validity of these provisions.
The Court first addressed whether Optum could condition payment of the merger consideration on Cigna’s execution of the release. Cigna argued that the Merger Agreement entitled it to payment, so the Letter of Transmittal constituted a contract with no additional consideration. The Court agreed, and held that the requirement that the plaintiff stockholder sign the release before receiving the consideration was unenforceable. The Court rejected the imposition of extra conditions in the Letter because the Merger Agreement “provided no indication to stockholders that they might have to agree to a release,” and therefore if the Court permitted this requirement to be placed upon the seller, “then buyers could impose almost any post-closing condition or obligation on the target company’s stockholders after the fact by including it as a requirement in the letter of transmittal.”
The Court then turned to the Merger Agreement’s indemnification provision, which made the former Audax stockholders liable up to their share of the merger consideration for breach of certain representations and warranties, some of which would survive indefinitely. Cigna argued that this indemnification provision violated Section 251(b) of the DGCL, because it placed all of the consideration potentially at risk for an unlimited period of time. Under Section 251, a merger agreement may contain terms dependent on facts ascertainable outside of the agreement, including “a determination or action by any person or body,” so long as the agreement “clearly and expressly” sets forth the manner in which such facts would operate. Optum argued that it complied with Section 251 and that, if the Court were to strike down this provision, it would jeopardize the use of escrow arrangements more generally.
The Court concluded that the case raised a novel issue under Section 251: “despite literally complying with the ‘facts ascertainable’ provision of Section 251(b), the value of the merger consideration itself is not, in fact, ascertainable, either precisely or within a reasonable range of values.” The Court therefore held that the indemnification obligation violated Section 251(b)(5)’s requirement that a merger agreement state “the cash, property, rights or securities of any other corporation or entity which the holders of such shares are to receive.” To reach this holding, the Court considered it crucial that “the stockholders may never know the exact value of the merger consideration ….” (emphasis original). The Court reasoned that stockholders would otherwise remain forever potentially liable for the entire amount of the merger consideration.
The Court expressly limited its holding, however, to the “combination” of the factors present in the case, namely “indefinite length and the contingent nature of the entirety of the consideration ….” Further, the Court held that provisions requiring individual stockholders to potentially repay part of their merger consideration – as opposed to the use of an escrow fund – “occupy an uncertain status under Delaware law.” The Court expressly stated that the opinion does not consider escrow agreements, nor even any stockholder indemnity that does not threaten to last forever and recoup all the merger consideration.
The Court briefly addressed three other issues. First, Cigna challenged the validity of a provision in the Support Agreement that would appoint a stockholder representative, but only insofar that this obligation was “inextricably intertwined” with the indemnification provision. The Court noted that “[t]he propriety of stockholder representatives under the DGCL is the subject of active and ongoing debate,” and held that this argument “would seem to fall away” because the indemnification obligation was void. The Court nevertheless denied the motion for judgment on the pleadings “to the extent it challenges the Stockholder Representative Obligation.”
Second, Cigna argued the indemnification provision violated DGCL Section 102(b)(6), which states that stockholders shall not be liable for the debts of the corporation unless a provision in the certificate of incorporation permits personal liability. Cigna maintained that Audax could not circumvent Section 102(b)(6)’s prohibition in this regard, and pass liability for breaches of representations and warranties on to stockholders via the indemnification provision. The Court held that this was a novel but unavailing argument, because Section 251 applied to the Merger Agreement, not Section 102(b)(6). The Court had already held that the indemnification provision was void because it violated Section 251 and therefore declined to consider the argument further.
Third, Cigna argued that the indemnification provision violated Audax’s Certificate of Incorporation (“COI”). The COI required preferred stockholders to receive the greater of either the liquidation preference or what they would receive had their shares been converted into common stock. Cigna argued that it should receive the amount the common stockholders would receive without the obligations imposed by the indemnification provision. Since the Court had already held the indemnification provision unenforceable against Cigna, it concluded that the merger consideration would not fall below the liquidation preference, so this argument was moot.