Merger Remedies Unbound

How should foundational contract law doctrines apply to corporate mergers? In a forthcoming paper, we argue that recent changes in Delaware law grant parties an unprecedented degree of contractual freedom to define their preferred remedies in merger agreements, far beyond the limits imposed by traditional contract law. Delaware’s newly permissive attitude toward contractual remedies in mergers stems from a legal dispute about “lost premium” provisions, which allow target companies to recover the premium that their shareholders were promised, in case the buyer breached the agreement and the merger failed to close. In Crispo v. Musk, the Delaware Chancery Court held that Twitter could not enforce the lost premium provision in its merger agreement with Elon Musk after Musk attempted to walk away from the transaction. The Crispo court based its decision on contract law’s anti-penalty doctrine. Under this doctrine, liquidated damages—the contractually stipulated sums intended to compensate the injured party—must not be unreasonably large. The decision came as a surprise to many practitioners, and raised concerns that buyers could opportunistically walk away from deals without compensating the target.  Several months later, the Delaware legislature responded to these concerns and amended the Delaware corporate statute, expressly overriding the Chancery Court’s Crispo ruling and allowing targets to collect the lost premium when such a provision is stipulated in a merger agreement, as was the case in the Twitter deal.

The Delaware legislature’s endorsement of lost premium provisions, despite concerns over their compatibility with the anti-penalty doctrine, is consistent with a parallel, longer-running trend in Delaware jurisprudence: an increasingly contractarian approach to specific performance.  Traditionally, courts have exercised substantial discretion over determining whether an injured party is entitled to specific performance as a remedy, regardless of whether an agreement expressly provides for it. Recently, however, Delaware courts have grown far more willing to enforce specific performance provisions in merger agreements as written.

The legislative response to Crispo and the Delaware courts’ growing deference to negotiated specific performance provisions, taken together, signal a broader shift toward allowing contracting parties wide-ranging freedom to dictate their preferred remedy with minimal judicial interference. But this increasing deference to party-drafted remedies raises crucial questions about the appropriate boundaries of contractual freedom. To what extent should the parties’ stipulated remedy in a merger agreement be enforced as written? How should courts and legislatures balance deference to private ordering with the equitable principles that traditionally govern the enforcement of remedies? More fundamentally, what remedy should a disappointed party be entitled to when a merger falls apart?

The paper argues that while the statutory amendment overriding the Crispo decision appears to resolve the controversy over the lost premium provision, a development we view as desirable, it has simultaneously introduced a broader tension with foundational principles of contract law. The new amendment to the Delaware corporate code authorizes a form of unchecked contractarianism, arguably shielding liquidated damages provisions from any scrutiny under the anti-penalty doctrine. For instance, the plain language of the amended statute potentially allows targets to require a punitive reverse termination fee if the buyer does not close the deal.

Moreover, under the amended statute, this escape from the anti-penalty doctrine would apply only when the termination fee is triggered based on one party’s breach, but not when the party is obligated to pay the fee without breaching the agreement. As a result of the statutory amendment, Delaware law’s treatment of termination fees (and other liquidated damages such as the “lost premium” provision) in mergers has arguably become “bifurcated,” with the application of the anti-penalty doctrine depending on whether a court finds that a party has breached the agreement. This bifurcation of merger remedies is a significant development that has arguably made Delaware law less predictable for transactional planners. Such increased uncertainty can lead to more litigation between merging parties about whether a “breach” actually occurred and whether the termination fee is under the purview of the amended statute.

The paper also applies insights from economic theory to analyze how the new contractarianism can impede efficient dealmaking. First, parties that have incomplete information about the transaction can agree to suboptimal and inefficient remedy terms. For instance, a buyer that is not fully informed of the risks associated with the deal can commit to paying an excessively large reverse termination fee in case it cannot consummate the deal. This large fee may preclude the buyer from later walking away from the transaction, even if breaching would otherwise have been efficient ex post. Second, if there are substantial agency problems between managers and their shareholders, the managers can use their newfound contractual freedom to commit their companies to mergers that are not in the best interests of their shareholders. For example, if a manager stands to personally obtain financial benefits from a merger, they can agree to pay excessively high termination fees in order to “lock in” to a merger that is beneficial to them but not to their shareholders.

Third, the paper also discusses how unchecked contractarianism can engender negative consequences on non-contracting third parties. For one, although the legislative amendment was more relevant for buyer-side remedies such as lost premium and reverse termination fees, the broader contractarian shift it reflects can extend to other terms, including termination fees imposed on the target if it withdraws from the deal and instead sells itself to another buyer. An excessively large target termination fee could deter third-party bidders from competing against the initial acquirer, even if they value the target more highly and the efficient outcome would be for the target to accept their offer. Enforcing the specific performance provision in favor of the initial acquirer can also have a similar effect. Another third-party harm from unchecked contractarianism is that an unreasonably large reverse termination fee can potentially frustrate the government’s competition policy. For instance, a buyer may be obligated to pay a reverse termination fee if the buyer fails to secure regulatory approval from antitrust authorities. The larger this reverse termination fee, the stronger the buyer’s incentives to secure antitrust approval to close the transaction. With a large reverse termination fee, the buyer may become “over-committed” to consummate the merger even when the merger is anticompetitive. We could, for instance, see buyers more vigorously and even successfully challenging the antitrust authorities, by taking regulators to court and appealing any adverse judgment. More anticompetitive mergers can ultimately harm consumers, employees, and suppliers.

We argue that the Delaware legislature and courts ought to recognize the potential downsides of unrestrained contractarianism. Specifically, we think legislators ought to clarify that merger remedies will not differ based on whether a termination fee was triggered by a party’s breach of the merger agreement. Moreover, we suggest that they should amend the corporation code to explicitly state that recent changes to the law of merger remedies preserve the traditional corporate and contract law limits on merger remedies, as well as the courts’ discretion over whether to order specific performance. Courts, for their part, should continue to invalidate excessively large termination fees and only order specific performance when they deem monetary damage provisions to be inadequate. We further suggest that courts should invalidate excessively high reverse termination fees tied to the buyer’s failure to receive regulatory approval, as these provisions are contrary to public policy due to their potential anticompetitive effects. To restore efficiency and predictability in its merger jurisprudence, Delaware should consider a retreat from unchecked contractarianism.

The complete paper is available here.