Before I get started on the meat of this week’s post, I just want to take a brief moment to say I am honored and delighted that, at the Journal of Corporation Law’s invitation, Steve Bainbridge wrote a response to my paper, The Legitimation of Shareholder Primacy.
Steve’s response, which you can find on SSRN here, is not so much as a rebuttal as it is a complement. (He also has a couple of shorter blog posts, here and here.) I approach the recent controversies in corporate law – and DExit in particular – as arising out of an ongoing need among corporate actors to legitimate the power that corporations wield and the legal system that sustains that power; Steve approaches the matter through an interest group lens. He characterizes Delaware lawmaking as an exercise in balancing the different interests of the legislature, bar, and judiciary, and analyzes the recent contretemps from that vantagepoint. As he explains, our different takes are not mutually exclusive, and I think he is exactly right in terms of the delicate balancing act that the different Delaware actors must perform. If I have anything to add, it’s only this: Steve recognizes that these three actors are all involved in the mutually-beneficial project of enhancing Delaware’s franchise, but also puts their specific interests at odds. I tend to view the problem as more short-term/long-term; choices that immediately retain incorporations – like hasty legislation – may do longer term reputational damage, and hobble production of the cases Delaware needs to keep its law relevant. It’s not an easy problem to solve.
Moving on –
I am in no way a contracts expert but every now and then I kind of marvel at some of the contract catastrophes that come out of Delaware, and recently there were three doozys. With the caveat that, as not-a-contracts-professor, I am not at all familiar with the background caselaw so any commentary of mine is just gut reaction, here we go.
And – whoops this got long, under the cut it goes.
First up, Feeney Brothers Excavation Trust v. Artera Services Holdco.
CD&R has been rolling up various utility-related businesses into an umbrella firm called Artera. Artera wanted to add another business to its portfolio, namely, a utility construction business owned by the Feeney brothers. Artera offered to pay cash and equity in Artera itself. That meant it was really important to the Feeneys what that equity was actually worth. There were slide presentations and oral representations to the effect that Artera was worth $160 per share, but the Feeneys did not, apparently, receive any kind of independent appraisal (or, as far as I can tell, a documented appraisal of any kind). Obviously, as the reader can guess by now, it turned out that Artera was worth far, far less than $160 per share, and the Feeneys sued for breach of contract and fraud.
The problem was, the contract contained a non-reliance clause, and in Delaware, it’s reasonably well-established that these are effective with respect to extra-contractual representations, but cannot bar claims based on representations in the contract itself. So, the Feeneys needed to find some language in the purchase agreement purporting to establish the value of the Artera shares.
The language they found was in the Recitals section, which contained various definitions. One of the definitions was:
“Artera Units” references “a number of fully vested Common Units (as defined in, and having the rights, powers, preferences and obligations set forth in, the Artera Agreement) equal to the number of the Exchange Units with an aggregate value equal to the Rollover Amount and with each Artera Unit having a value of $160.00.”
So, the Feeneys’ position was, the consideration they received – Artera Units – was defined to mean, Units valued at $160 each, and since they did not receive that, Artera breached the contract and/or committed fraud.
The court denied the claim, on the ground that everyone knows recitals are not actually part of the contract and cannot bind the parties. And that was particularly true in this case, because one of the operative parts of the contract explicitly stated that “no representation or warranty, express or implied, whether written or oral, as to the financial condition, results of operations, prospects, properties, or business of Artera or as to the desirability or value of an investment in Artera has been made to the [Feeney Trust] by or on behalf of Artera, except for those representations and warranties expressly set forth in Section 2 of this Agreement.” I.e., to read the recitals as the Feeneys did would have them contradict other parts of the agreement.
My personal instinct here is that “recitals” are treated as meaningless because they usually say things like “Whereas, the parties want to make a deal.” If the “recitals” do more than that, they aren’t recitals anymore. The label of “recital” shouldn’t be doing the legal work, is what I mean; what should matter is whether the section actually contains what we usually think of as a recital. If it doesn’t – if it contains definitions – then it’s a definition section no matter what the label. Which, in this case, given the contradictory contractual terms, might render the whole contract ambiguous, so that the Feeneys’ claims would at least make it past a motion to dismiss.
But, on the other hand – they sold their business based on a valuation in a slideshow, attributed to “the work of an independent third-party valuation consultant”? Eep.
The next case, Verisk Analytics v. Exactlogix, actually did go to trial, and, incidentally, the court ordered specific performance of a merger, accepting a contractual stipulation that damages would not provide adequate relief, so put that in the column that Delaware is moving further and further away from treating specific performance as a remedy that requires a heightened showing of necessity. But I digress.
The actual dispute was about antitrust clearance. The contract contained the usual obligations that the parties would use commercially reasonable efforts to win FTC approval. At the time of the deal, the buyer had been in negotiations with one of the target’s competitors over a service contract, but once the deal was struck, it canceled those negotiations. FTC found out about the cancelation and started to ask the buyer whether it had ever terminated negotiations with a competitor of the target. The buyer’s representatives repeatedly said “no” – which was not true, and FTC knew it. But according to trial findings, the misrepresentations were entirely accidental; for reasons, the representatives genuinely did not realize that this was what FTC was asking about.
Anyhoo, all of this created some distrust at the FTC that led to it broadening the scope of the investigation. Eventually, the buyer’s antitrust counsel discovered the mixup and gave the FTC the information it wanted, but it was too late – now FTC wanted a much broader review. But also, the outside date had passed without satisfaction of a precondition (antitrust clearance) so the buyer terminated the agreement, and the target sued.
The question, then, was whether this was a valid termination, and that turned on whether the failure of the antitrust precondition was the buyer’s fault. Which in turn depended on the very specific language of the contract: that termination was not permitted
if such party’s failure to fulfill its obligations or to comply with its covenants under this Agreement, or other willful conduct, has been the primary cause of, or primarily resulted in, the failure to satisfy any condition to the obligations of the Parties hereunder
Was there “willful conduct” here? The conduct was “willful” in the sense that the employees’ actions were not involuntary: no one was manipulating their limbs like puppets, their FTC responses were not the product of a muscle spasm. But it was not “willful” in the sense of openly defying the FTC; the employees honestly didn’t realize what the FTC was going for.
The court held that “willful conduct” simply meant not involuntary conduct, largely because other parts of the merger agreement used the phrase “willful breach,” and the court figured that the different terms should be interpreted to have different meanings.
Specific performance – which in this case meant continued efforts to obtain FTC clearance – ordered.
Finally, we have Kentucky Downs Management v. Kentucky Downs LLC, which also made it to trial.
In this case, the buyers wanted to purchase the Kentucky Downs horse racing facility, but at the time, the facility was enmeshed in litigation over the legality of its historical horse race terminals under Kentucky law. If the track was forced to shut them down, it could result in catastrophic losses. So, the buyers and sellers agreed that the buyer would withhold $10 million of the purchase price until the case was resolved. If there was a final, unappealable adverse judgment by a certain date, the buyer would keep the $10 million; if not, the buyers would pay the sellers.
There was such an adverse judgment, but the buyers were able to lobby the legislature to get the law changed, ultimately with no harm to the business. Did the buyers still get to keep the $10 million?
Yes, said the court. Originally, the contract had been structured to treat the $10 million as part of an escrow for “indemnifiable losses,” which also included a potential unfavorable outcome in a completely different and unrelated case. But that other case was resolved during the negotiations, and when they restructured the contract, they removed all the language about indemnifiable losses, and simply stated that the buyers would not have to pay the $10 million in the event of an adverse judgment. Thus, the court concluded, the concept of “adverse judgment” was distinct from the concept of loss, and the buyers got to keep the $10 million regardless of loss’s lack. After all, noted the court, nothing would have been more foreseeable to businesspeople than the principle that if you don’t like the law, you lobby to get it changed.
And so I conclude with: This was a case about a Kentucky asset purchase involving issues that could not have been more local to Kentucky if they had come poured in a bottle of bourbon. And yet still, they were litigated in Delaware under Delaware law, presumably because that’s what the contract specified. Delaware’s courts still have a lot going for them.
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