Analysis of Lost Premium Damages Provisions Following the Adoption of DGCL Section 261 Amendments
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Effective August 1, 2024, Delaware adopted a set of amendments to the Delaware General Corporation Law (the "DGCL") intended to address, among other things, the Delaware Chancery Court's 2023 decision in Crispo v. Musk.1 In the Crispo decision, the Chancery Court stated in dicta that a Delaware target company in a merger could not collect damages from a breaching buyer reflecting any premium or other economic benefits that its stockholders would have been entitled to receive if the merger had been consummated ("lost premium damages") where the agreement expressly provided that stockholders are not third-party beneficiaries of the agreement for such purposes. The Crispo decision took many Delaware practitioners by surprise as it has been widely assumed that such damages could be provided for in a merger agreement. The Delaware General Assembly and Governor moved swiftly to address the decision.
This article (i) reviews the background to the history of lost premium damages provisions, (ii) addresses the prevalence of lost premium damages provisions following the adoption of the amendments to Section 261 of the DGCL, (iii) discusses the interplay among lost premium damages, other remedies and reverse termination fees, and (iv) identifies some key practice pointers. The analysis contained herein is based on a survey of a selective set of definitive merger agreements executed between August 1, 2024 and December 31, 2024.2
Background
Case Law
In 2005, in Consolidated Edison v. Northeast Utilities3 (commonly known as Con Ed), the United States Court of Appeals for the Second Circuit, applying New York law, held that a target company's shareholders could not pursue a claim for lost premium damages (which were provided for in the merger agreement between the parties) against the buyer for its failure to close the merger. In its decision, the Second Circuit examined the agreement's provisions and concluded that: (i) the agreement only granted third-party beneficiary status to the target company's shareholders at and following the merger's effective time, noting that the parties to the merger agreement "clearly took pains to assure that the [shareholders' third-party beneficiary] right was limited to a right to collect the shareholder premium if and when the merger happened, not a right to sue to compel completion of the merger or for damages resulting from a party's refusal to merge;"4 and (ii) liability for a willful and material breach of the merger agreement only applied to "'liability or damage suffered by the party,' not by non-parties, and therefore not by [the target company's] shareholders."5
For almost two decades following the Second Circuit's Con Ed decision, it was unclear whether Delaware would follow the decision. Practitioners generally assumed that target companies and/or their stockholders could seek lost premium damages from a breaching buyer under Delaware law and responded (or declined to respond) to the Con Ed decision in various ways.6 Specifically, while most Delaware practitioners chose to remain silent on the issue in merger agreements, either presuming that the target company's stockholders (or the target company on their behalf) could or could not collect lost premium damages, other practitioners included various provisions in merger agreements in an attempt to address the issue. These provisions, which took various forms, generally provided that the target company could collect such damages on behalf of its stockholders and sometimes provided that the stockholders were third-party beneficiaries of the agreement for these purposes.
In its 2023 decision in Crispo, the Chancery Court addressed the issue of lost premium damages in an unusual context – an action by stockholder Crispo to recover a mootness fee for his role leading to the closure of the acquisition of a leading social media platform company, which turned on whether Crispo had third-party beneficiary status to sue for lost-premium damages under the merger agreement.7 In reaching its decision that Crispo was not entitled to a mootness fee, the Chancery Court suggested in dicta that Delaware would follow the Second Circuit's Con Ed approach. Specifically, the Court found that Crispo was not entitled to recover lost premium damages against the breaching buyer because even though the merger agreement expressly provided for the recovery of lost premium damages by the non-breaching target company, it also expressly provided that the stockholders were not third-party beneficiaries of the merger agreement for purposes of recovering such damages.
The Court analyzed the agreement's "No Third-Party Beneficiaries" provision, which provided "a blanket prohibition disclaiming third-party beneficiaries followed by three carve-outs,"8 none of which covered third-party beneficiaries in the scenario of lost premium damages and concluded that the parties therefore intended to disclaim stockholders as third-party beneficiaries for such purposes. Further, the court analyzed the lost-premium damage provision and effect of termination section of the merger agreement and concluded "[b]ecause only the target [company] stockholders expect to receive a premium in the event a merger closes, a damages-definition defining a buyer's damages to include [payment of] lost-premium damages is only enforceable if it grants stockholders third-party beneficiary status," which the agreement failed to do.9
The Amendments to DGCL 261
The Delaware General Assembly amended DGCL Section 261 to add Section 261(a)(1) to address the Crispo decision. Under Section 261(a)(i), a breaching party to a merger agreement is subject to "such penalties or consequences as set forth in the agreement of merger or consolidation (which penalties or consequences may include an obligation to pay to the other party or parties to such agreement an amount representing, or based on the loss of, any premium or other economic entitlement the stockholders of such other party would be entitled to receive pursuant to the terms of such agreement if the merger or consolidation were consummated in accordance with the terms of such agreement)."10 Further, if a damages payment is made to either the target company or the buyer, the receiving party may keep the payment without having to distribute the payment to its stockholders, even though the stockholders are the ones who had been expected to receive the premium if the merger had closed.11 Finally, an agreement may include a provision appointing representatives to act on behalf of the target company's stockholders and the buyer's stockholders to enforce the stockholders' respective rights under the agreement.12
Prevalence of Lost Premium Damages Provisions
Of the 38 merger agreements reviewed,13 22 of them (58%) provided for lost premium damages and 16 (42%) did not. The fact that slightly less than one-half of the agreements did not provide for lost premium damages is presumably due to the following reasons:
- As discussed in greater detail below, of the 16 merger agreements that did not provide for lost premium damages, 13 of them (81%) followed the private equity model, which generally limits the target company's remedies in the event the buyer fails to close the transaction in breach of the agreement to a reverse termination fee from the buyer and the right to sue the buyer for damages capped at the amount of that fee;
- The outcome of arms' length negotiations between the parties regarding the issue; or
- An oversight by the parties in light of the relatively recent adoption of the amendments to Section 261(a)(i).
Interplay Among Lost Premium Damages, Other Remedies and Reverse Termination Fees
Merger agreements in public M&A transactions generally provide for a combination of remedies for the target company in the event of a buyer breach. These remedies usually include the right of the target company (i) to specifically enforce the buyer's obligation to satisfy its obligations under the merger agreement, including its obligation to close the transaction if all of the conditions precedent to the buyer's obligation to do so are satisfied, or (ii) to terminate the agreement and sue for damages. There are different variations of these two remedies and the interplay between these remedies and any reverse termination fee that is provided for in the merger agreement. Most importantly, these remedies packages and related provisions generally differ significantly depending on whether the buyer is a strategic buyer or a private equity or other financial buyer that generally relies on leverage to fund the acquisition.
The most common remedies structure for transactions involving a strategic buyer provides for (i) full specific performance to enforce the buyer's obligations under the merger agreement, including the buyer's obligation to close the transaction if all the conditions precedent to the buyer's obligation to do so are satisfied, and (ii) damages in the event of a willful breach or fraud by the buyer, and in some cases any breach by the buyer (the "strategic model"). A significant minority of merger agreements following the strategic model provide for the payment of a reverse termination fee by the buyer to the target company in specified circumstances, including, most commonly, the failure of the buyer to close the transaction when it is required to do so, a breach by the buyer that causes the failure of a closing condition, or the failure to obtain specified regulatory approvals (a "regulatory failure"). In circumstances in which the reverse termination fee is payable, the fee payment is generally the target company's sole and exclusive remedy.
The most common remedies structure for transactions involving private equity and similar financial buyers that rely on leverage to fund acquisitions provides for (i) conditional specific performance under which the target can specifically enforce the buyer's obligations under the merger agreement, including the buyer's obligation to fund the equity portion of the purchase price and close the transaction if all of its conditions to do so are satisfied, but only if the buyer's debt financing is available, (ii) a reverse termination fee payable by the buyer to the target company if the buyer fails to close, whether due to a failure of its debt financing or breach, and (iii) damages for willful breach or fraud by the buyer capped at the amount of the reverse termination fee (the "private equity model"). In circumstances in which the reverse termination fee is payable, the fee payment is the target company's sole and exclusive remedy for the buyer's failure to close the transaction.
Under the strategic model, lost premium damages could be a principal remedy (in addition to specific performance) for the target company in the event of a willful breach of the merger agreement or fraud by the buyer. Even where the merger agreement provides for a reverse termination fee payable in the event of certain breaches by the buyer, lost premium damages may play an important role (i) if that fee does not serve as the sole and exclusive remedy of the target company or as a cap on the target company's damages in the event of such a breach, or (ii) as a basis for recovery of damages in excess of the target company's own damages where the fee serves as a cap on the target company's damages but is not the target company's sole and exclusive remedy in such circumstances.
Under the private equity model, both the need for, and the ability of the target company to collect, lost premium damages are greatly reduced due to (i) the availability of a reverse termination fee in the event of certain breaches by the buyer (including, in most cases, the buyer's failure to close the transaction when contractually required to do so), (ii) the fact that in circumstances in which the reverse termination fee is payable, the reverse termination fee is the target company's sole and exclusive remedy, and (iii) the fact that the target company's damages for a willful breach or fraud by the buyer are usually capped at the amount of the reverse termination fee.
Of the 38 merger agreements reviewed, 25 of them followed some version of the strategic model and 13 of them followed some version of the private equity model.
Of the 25 merger agreements that followed the strategic model, 19 (76%) provided for lost premium damages and only six (24%) did not. All six merger agreements that did not provide for lost premium damages provided for a reverse termination fee, which may suggest that in those transactions the target companies were more concerned about a regulatory failure and/or the buyer's breach in circumstances where it would be required to pay the target company a reverse termination fee, and less concerned about breaches by the buyer in other circumstances.14 Of the 13 merger agreements that followed the private equity model, only three (23%) included lost premium damages provisions. Accordingly, it appears that the primary determinant of whether a merger agreement provides for lost premium damages is whether the agreement follows the strategic model or the private equity model.
Practice Pointers
The merger agreements that provided for lost premium damages followed different formulations. Based on the text of the amendments to Section 261, market practice since the adoption of the amendments, and the views of leading Delaware practitioners, set forth below are some things to keep in mind when drafting and negotiating lost premium damages provisions in merger agreements:
1. Lost Premium Damages Provisions May Not Be Necessary or Effective: As discussed above, lost premium damages may be less necessary or useful from the target company's perspective under the private equity model than under the strategic model because under the private equity model (i) target companies are entitled to a reverse termination fee for buyer's failure to close or for the buyer's breach in many circumstances, (ii) lost premium damages are not recoverable where the reverse termination fee is the target company's sole and exclusive remedy, and (iii) the reverse termination fee serves as a cap on the target company's damages. In addition, in the private equity model the buyer is usually a shell company whose ability to pay damages is dependent on a limited guarantee from its equity investors that usually covers only the amount of the reverse termination fee, certain limited financing-related indemnification obligations, and enforcement costs. In these circumstances, a lost premium damages provision will have limited utility for a non-breaching party.
2. Silence is Not Golden: To recover lost premium damages in the event of breach or fraud, the DGCL requires that the merger agreement specify that the non-breaching party may pursue lost premium damages.
Section 261(a)(1)(i) notes that a breaching party is subject to remedies available at law or in equity in addition to "such penalties or consequences as set forth in the agreement of merger or consolidation."15 Absence of a lost premium damages provision most likely precludes a non-breaching party from collecting these damages. Consequently, the merger agreement must include express reference to lost premium damages when referring to the monetary damages that the non-breaching party may seek (e.g., loss of the benefit of the bargain, loss of the stockholder premium, or loss of the economic entitlement the non-breaching target company would be entitled to receive if the merger had been consummated).
3. Name the Company as the Stockholders' Representative and not as their Agent: The lost premium damages provision should track the language of DGCL Section 261(a)(2)(i) to provide that the non-breaching company is a "representative" of its stockholders.16 Surprisingly, of the 22 merger agreements that included lost premium damages provisions, only one (4.5%) identified the target company as the stockholders' representative, while seven (32%) identified the target company as the stockholders' agent. The remainder of the agreements were silent on this point.
4. State That Stockholders are Third-Party Beneficiaries: For clarity, state that the stockholders are third-party beneficiaries of the merger agreement with respect to lost premium damages. Of the 22 merger agreements that included lost premium damages provisions, only six (27%) expressly referred to stockholders as third-party beneficiaries.
The merger agreement in Crispo included a "No Third-Party Beneficiaries" provision with specific carve-outs; the Chancery Court inferred that the contracting parties intended to grant third-party beneficiary status only in the narrow circumstances covered by the carve-outs. The Chancery Court noted: "When a provision is customized, this court has concluded that the parties knew how to confer third-party beneficiary status and deliberately chose not to do so with respect to any unlisted groups."17 As such, the Chancery Court determined that the target company's stockholders, who were not included in a carve-out with respect to lost premium damages, were not intended third-party beneficiaries of the right to pursue lost premium damages. Accordingly, if the merger agreement intends to allow the non-breaching party to pursue lost premium damages on behalf of its stockholders, it is best to affirmatively note that the non-breaching party's stockholders are third-party beneficiaries of the agreement.
5. State that the Non-Breaching Party May Retain any Lost Premium Damages It Recovers: For clarity, state that the non-breaching party may retain, without distribution to its stockholders, any lost premium damages recovered from the breaching party. Of the 22 merger agreements that included a lost premium damages provision, eight (36%) expressly stated that the non-breaching party may retain, without distribution to its stockholders, any lost premium damages recovered.
DGCL Section 261(a)(2)(ii) states that "if, pursuant to the terms of such agreement, a corporation is entitled to receive payment from another party to an agreement of merger or consolidation of any amount representing such a penalty or consequence (as specified in clause (i) of this paragraph (a)(1)), such corporation shall be entitled to enforce the other party's payment obligation and, upon receipt of any such payment, shall be entitled to retain the amount of such payment so received."18
6. Cite to Authority: While not expressly required, it is prudent to expressly refer to Section 261 of the DGCL when referencing lost premium damages. Of the 22 merger agreements that included a lost premium damages provision, only two (9%) expressly cited to Section 261 of the DGCL in their lost premium damages provisions.
1 304 A.3d 567 (Del. Ch. 2023).
2 The survey reflects a review of merger agreements meeting the following criteria: (i) public deals, (ii) announced between August 1 and December 31, 2024, (iii) governed by Delaware law, (iv) with a minimum equity value of $250 million, and (v) providing for the acquisition of 100% of the target company's outstanding equity. The survey omits one merger agreement that met these criteria but had anomalous remedies provisions.
3 426 F.3d 524 (2d Cir. 2005).
4 Con Ed at 528.
5 Con Ed at 531.
6 For a more detailed summary of the Amendments, please refer to W&C's article, "The Delaware General Assemble to the Rescue: Proposed legislative Fixes to Uncertainty Created by Three Significant Delaware Chancery Court Decisions."
7 Id. at 570.
8 Id. at 578.
9 Id. at 584.
10 DGCL 261(a)(1)(i)
11 DGCL 261(a)(1)(ii).
12 DGCL 261(a)(2)(i).
13 See footnote 2.
14 However, it is worth noting that all six of these merger agreements also provided for uncapped damages for willful breach by the buyer, for which lost premium damages would be relevant where the reverse termination was not the target company's sole and exclusive remedy.
15 DGCL 261(a)(1)(i) (emphasis added).
16 Section 261(a)(2)(i) notes that one or more persons (which may include the surviving or resulting entity) should be designated as the stockholders' representative to enforce the stockholders' rights under the agreement.
17 Id. at 574.
18 DGCL 261(a)(1)(ii) (emphasis added).
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