United States: Re-Examining The M&A Playbook For Non-Consenting Stockholders In Light Of Cigna Health

In a case that is likely to impact M&A structuring for certain transactions, the Delaware Court of Chancery held that (1) stockholder release obligations found only in a letter of transmittal and not in the related merger agreement were unenforceable against non-consenting stockholders for lack of independent consideration and (2) indemnification obligations contained in the merger agreement that were unlimited with respect to time and value rendered the merger consideration undeterminable and thus, as they related to the non-consenting stockholders, not compliant with Section 251 of the Delaware General Corporation Law (DGCL).

The case, Cigna Health & Life Ins. Co. v. Audax Health Solutions, Inc., C.A. No. 9405-VCP (Del. Ch. Nov. 26, 2014), involves the acquisition of Audax Health Solutions, Inc. (Audax) by Optum Services, Inc. (Optum), a subsidiary of UnitedHealth Group Inc. (United). The plaintiff in the case, Cigna Health and Life Insurance Co. (Cigna), was a minority stockholder in Audax.

The Merger

On February 10, 2014, the Audax board of directors approved a merger with Optum. The merger was subsequently approved without a stockholder meeting by the written consent of 66.9 percent of Audax stockholders entitled to vote. Cigna withheld its consent to the merger. The merger was consummated on February 14, 2014.

Written consents to the merger were provided in the form of support agreements signed by the consenting stockholders that included, among other things:

The Release Obligations were not contained in the merger agreement. While the Indemnification Obligations were contained in the merger agreement, they made the selling Audax stockholders indefinitely liable to United, up to their pro rata share of the merger consideration, for breaches of certain of the representations and warranties in the merger agreement, including those relating to corporate organization, capitalization, taxes, and environmental and intellectual property matters.

Under the terms of the merger agreement, receipt of the merger consideration by non-consenting Audax stockholders was conditioned on their execution and delivery of a letter of transmittal containing the Release Obligations and the Indemnification Obligations.

Cigna did not sign a support agreement nor did it execute a letter of transmittal, believing that the Obligations violated the DGCL and that its right to receive the merger consideration vested unconditionally upon consummation of the merger. After United refused to pay Cigna its pro rata share of the merger consideration, Cigna filed a lawsuit against United, Audax, and the paying agent for the merger, challenging the validity of the Obligations.

The Holding

The Delaware Court of Chancery held that the Release Obligations contained in the letter of transmittal represented a new post-closing obligation that United and Audax sought to impose on non-consenting stockholders of Audax and, as such, required independent consideration beyond the consideration supporting the merger agreement. As the Release Obligations were unsupported by independent consideration, the Cigna court found them unenforceable against the non-consenting stockholders.

The Delaware Court of Chancery also found that the Indemnification Obligations, as they applied to the non-consenting stockholders, violated Section 251 of the DGCL because they prevented stockholders from determining the ultimate value of the merger consideration with any degree of precision. Section 251 governs mergers of Delaware corporations and establishes a number of requirements for a merger agreement to be enforceable. One of these requirements, in the words of the Delaware Court of Chancery, is that the value of the merger consideration must be, "in fact, ascertainable, either precisely or within a reasonable range of values."¹ The Cigna court held that "while individual stockholders may contract – such as in the form of a Support Agreement – to accept the risk of having to reimburse the buyer over an indefinite period of time for breaches of the merger agreement's representations and warranties, such a post-closing price adjustment cannot be foisted on non-consenting stockholders."

The Takeaway

The Cigna case has important implications for M&A practitioners. Parties to a merger transaction should now think twice before seeking to rely on robust letters of transmittal that are to be executed subsequent to the merger agreement by non-consenting stockholders and that contain or incorporate by reference release provisions, as well as other selling stockholder post-closing obligations that are not supported by independent consideration or are unlimited in scope. M&A professionals will also want to consider using all available tools to deal with non-consenting stockholders, including escrows, possibly additional consideration for consenting stockholders, and indemnity limits, even for fundamental issues like authority and title to stock.

Beyond the transaction documents, the traditional stockholder agreement, including the customary drag-along provision, now merits extra attention. While the Cigna case presents new obstacles to foisting post-closing obligations on non-consenting target stockholders, obtaining these concessions from minority stockholders "on the way in" rather than "on the way out" may be even more important now. By including a more forceful drag-along provision in the stockholder agreement, one that binds all stockholders to agree and consent to all post-closing obligations ancillary to, and in connection with, a change -in-control agreement negotiated by the controlling stockholders, a target company may avoid the release and indemnification issues raised in Cigna.

In addition, the Cigna case may lead to the more widespread use of representations and warranties insurance policies in certain M&A transactions. Although the use of such insurance has increased markedly in recent years as lawyers and bankers have become more comfortable with utilizing these policies, the Cigna decision may further support their use.

While the Cigna decision presents some challenges, well-advised targets and acquirers should still be able to accomplish most of their goals in dealing with non-consenting stockholders in M&A transactions.

Footnote

1. While the Delaware court held that the value of the merger consideration was unknowable and thus failed to satisfy the requirements of Section 251, it also stated the decision was limited to the combination of factors presented in the case, namely: the indefinite length and the contingent nature of the entirety of the merger consideration. The Delaware Court of Chancery explicitly did not rule on the general validity of post-closing price adjustments requiring direct repayment from selling stockholders.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.