So-called Con Ed provisions emerged as M&A practitioners’ response to Consolidated Edison, Inc. v. Northeast Utilities, a 2005 case in which the 2nd U.S. Circuit Court of Appeals held that stockholder plaintiffs did not have standing as third-party beneficiaries to sue for breach of a merger agreement due to a blanket prohibition on third-party beneficiaries in the merger agreement. The decision was widely viewed as upsetting the balance in leverage between selling and acquiring companies, and leaving selling companies at the mercy of acquiring companies, which could treat consummation of signed merger agreements as optional and allow acquirors to back out with little consequence.
The aim of Con Ed provisions is to hold buyers liable for lost stockholder premiums resulting from buyer-side breaches of merger agreements.
The types of Con Ed provisions practitioners have included in merger agreements are: (i) those that expressly create third-party beneficiary status in stockholders (the third-party beneficiary approach); (ii) those designating target companies as the agents to recover damages on behalf of their respective stockholders (the exclusive-agent approach); and (iii) those defining damages from the breach of merger agreements as lost premiums (the damages-definition approach).
The Delaware Court of Chancery recently limited the damages-definition approach and brought the other two approaches into question in Crispo v. Musk et al.
In Crispo, a stockholder of Twitter (plaintiff) filed a complaint for breach of fiduciary duty, specific performance and lost-premium damages (i.e., the difference between the agreed merger price and the fair market value of the shares when the alleged breach occurred) after Elon Musk (the buyer) purported to terminate his agreement to buy Twitter. Ultimately, Musk purchased Twitter in October 2022. The plaintiff then filed a petition for $3 million in mootness fees, arguing that: (i) the complaint would have survived a motion to dismiss; (ii) the buyer took beneficial action toward the corporation before judicial resolution; and (iii) the corporate benefit was causally related to plaintiff’s lawsuit.
Chancellor Kathaleen St. J. McCormick reasoned that only the lost-premium damages claim had to be decided since the two other claims had been fully argued and decided at the motion-to-dismiss stage; the court held at the motion-to-dismiss stage that (1) plaintiff’s complaint did not adequately allege Musk controlled Twitter before the transaction closed (so the breach-of-fiduciary-duty claim did not survive); and (2) the plaintiff lacked standing to bring a claim for specific performance for breach of the merger agreement.
The court held that plaintiff’s claim for lost-premium damages would not have survived a motion to dismiss because, under either of two potential interpretations of the merger agreement’s lost-premium provision (i.e., the Con Ed provision), plaintiff did not have standing as a third-party beneficiary to sue. Specifically, the court held that: (i) the damages-definition approach had the practical effect of defining damages to which Twitter was entitled in the event of a breach; and (ii) even if stockholders had third-party beneficiary status to sue for lost-premium damages, that status could have become effective only once specific performance was no longer available. Therefore, the court held that plaintiff was not entitled to a mootness fee.
The Court’s Analysis
The Con Ed provision at issue in Crispo stated that the buyer will be liable for “the benefits of the transactions contemplated by this Agreement lost by the Company’s stockholders [in the event of a breach] … taking into consideration all relevant matters, including lost stockholder premium.” The merger agreement also contained a blanket disclaimer as to third-party beneficiaries, which included several carve-outs that did not apply to stockholders’ rights to bring claims for lost premiums.
Under the court’s first interpretation of the damages-definition provision at issue in Crispo, the court held that, since the provision did not grant stockholders third-party beneficiary status, it had the practical effect of quantifying the target company’s damages from the breach of the merger agreement. The court held that it is well-settled law that a party may not receive more than its expectation damages in a contract dispute, so the expansion of Twitter’s damages to include lost stockholder premiums amounted to an unenforceable penalty against the buyer in the target’s favor.
Relying on the canon of contract construction that gives effect to all provisions wherever possible, the Court went on to consider an alternative interpretation of the merger agreement. Under the second interpretation, the Court construed the Con Ed provision as granting stockholders third-party beneficiary status to sue for lost-premium damages only once the merger had been abandoned (i.e., once the remedy of specific performance was no longer available). The Court held that plaintiff lacked standing when the complaint was filed because specific performance was still an available remedy at that time.
In dicta, the court also addressed the other two types of Con Ed provisions.
The court indicated that the third-party beneficiary approach also faces certain hurdles. The court stated that: (i) although specific provisions creating third-party beneficiaries may outweigh general no-third-party beneficiary provisions, general no-third-party beneficiary provisions containing specific carve-outs signal a strong intent to disclaim all third parties not included in the carve-outs; and (ii) Delaware courts, in particular, are reticent to recognize stockholders as third-party beneficiaries because it would upset: (a) Delaware’s board-centric model of corporate law, (b) the control boards have over their litigation assets, (c) the well-developed process of stockholder demand of boards prior to litigation (leading to a proliferation of stockholder suits), and, most importantly, (d) the primacy boards have over the corporate-sale process and their duty to get the highest value reasonably available.
The court stated that the exclusive-agent approach also rests on uncertain ground because there is no legal basis for one contracting party to unilaterally usurp a non-party’s enforcement control over the latter’s rights. In a footnote, however, the court considered whether the exclusive-agent approach could be better executed through charter provisions, quelling the concern over the status of stockholders (non-parties) versus the status of targets (parties) in relation to merger agreements.
- The court’s decision signaled that the exclusive-agent approach lacks any legal basis and that, in the future, companies may want to include such a relationship in a charter provision.
- The grant of third-party beneficiary status for the purpose of recovering stockholder lost premiums should be express, especially where there is a competing no-third-party beneficiaries provision with carve-outs.
- If a Con Ed provision is construed to be a damages-definition provision that creates a right to damages in the target company, it will be unenforceable.