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ASSET PURCHASE DEALS – SECURING VALUE & LIMITING LIABILITY, PART 1
& PART 2
First Run Broadcast: February 11 & 12, 2013
Live Replay: June 3 & 4, 2013
1:00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes)
In a difficult economy, “asset deals” are much more prevalent than “stock deals.” The buyer
prefers to acquire only specific assets of the seller rather than the seller’s entity and the liabilities
and other troubles that may go with it. The seller prefers a “clean” deal, where the buyer takes
the entity, all of its assets, employees and operations and liabilities. But even when a seller
agrees to an asset-only sale, there are real limits to the structure. Among others, common law
and statute frequently impose successor liability on the asset buyer. This program will provide
you with a real world guide to planning, structuring and drafting asset purchases, including
special due diligence and letter of intent issues, the form of consideration for the transaction,
successor liability and creditor issues, major tax considerations, and special challenges in
transferring specific types of assets.
Day 1: June 3, 2013:
Understanding the differences and risks and rewards of asset v. stock deals
Special due diligence considerations when assets are transferred
Techniques for transferring different types of assets – real estate, intangible property,
licenses, contracts and more
Representations and warranties when assets are transferred
Forms of consideration, including cash, equity in the buyer, and asset exchanges
Day 2: June 4, 2013:
Post-closing issues, including what happens to the seller’s entity?
Successor liability, creditor claim, and unknown liability issues – allocating the risk
among the parties
Employee issues –what if the buyer wants to retain seller employees?
Major tax issues, including IRC Section 338(h)(10) and state transfer tax issues
Special considerations when the seller is a pass-through entity
Speaker:
Tyler J. Sewell is an attorney in the Denver office of Morrison & Foerster, LLP, where he
specializes in mergers and acquisitions. He focuses his practice on advising financial and
strategic buyers and sellers in public and private M&A transactions and complex corporate
transactions. He negotiates and documents leveraged acquisitions, divestitures, asset
acquisitions, stock acquisitions, mergers, auction transactions, and cross-border transactions. Mr.
Sewell received his B.S., with merit, in ocean engineering from the United States Naval
Academy and his J.D., magna cum laude, from the University of Pennsylvania Law School.
Darren Hensley is a partner with Polsinelli Shughart, PC, where his practice emphasizing a
wide variety of corporate, securities, mergers and acquisitions, financings and general business
law matters and transactions. He has significant experience with mergers, stock sales and
purchases, asset sales and purchases, and public and private offerings of debt and equity. Mr.
Hensley received his B.A., magna cum laude, from Missouri Western State College, his M.B.A.
from the University of Kansas Graduate School of Business, and his J.D. from the Kansas School
of Law
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Asset Purchase Deals – Securing Value
& Limiting Liability, Part 1 Teleseminar June 3, 2013
1:00PM – 2:00PM
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Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: June 3, 2013 Seminar Title: Asset Purchase Deals – Securing Value & Limiting Liability, Part 1 Location: Teleseminar Credits: 1.0 General MCLE Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.
VT Bar Association Continuing Legal Education Registration Form
Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT 05601-0100. Fax: (802) 223-1573 PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name: _____________________ Middle Initial: _____Last Name: __________________________
Firm/Organization:____________________________________________________________________
Address:___________________________________________________________________________
City:__________________________________ State: _________ ZIP Code: ______________
Phone #:________________________ Fax #:________________________
E-Mail Address: ____________________________________________________________________
I will be attending:
Asset Purchase Deals – Securing Value
& Limiting Liability, Part 2 Teleseminar June 4, 2013
1:00PM – 2:00PM
VBA Members $75 Non-VBA Members $95
NO REFUNDS AFTER May 28, 2013
PLEASE NOTE: Due to New Hampshire Bar regulations, teleseminars cannot be used for New Hampshire CLE credit
PAYMENT METHOD:
Check enclosed (made payable to Vermont Bar Association): $________________
Credit Card (American Express, Discover, MasterCard or VISA) Credit Card # ________________________________________Exp. Date_______ Cardholder: ________________________________________________________
Vermont Bar Association
CERTIFICATE OF ATTENDANCE
Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: June 4, 2013 Seminar Title: Asset Purchase Deals – Securing Value & Limiting Liability, Part 2 Location: Teleseminar Credits: 1.0 General MCLE Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.
PROFESSIONAL EDUCATION BROADCAST NETWORK
Speaker Contact Information
ASSET PURCHASE DEALS – SECURING VALUE & LIMITING LIABILITY,PART 1 & PART 2
Darren HensleyPolsinelli Shughart, PC – Denver(303) [email protected]
Tyler J. SewellMorrison & Foerster LLP – Denver(o) (303) [email protected]
F E B R U A R Y 1 1 & 1 2 , 2 0 1 3P R E S E N T E D B Y
D A R R E N H E N S L E Y , P O L S I N E L L I S H U G H A R T P CT Y L E R S E W E L L , M O R R I S O N & F O E R S T E R , L L P
ASSET PURCHASE DEALS:SECURING VALUE & LIMITING LIABILITY
DAY 1
2
ASSET VS. STOCK DEALS
• Buyer purchases some or all of Seller’s assets• Seller may or may not remain in existence • Seller’s shareholders generally must approve
if “substantially all” of Seller’s assets• Generally favored by Buyer for tax and
liability reasons
3
ASSET VS. STOCK DEALS (CONT.)
• Advantages• Ability to select assets to purchase and
liabilities to assume/leave behind• Stepped-up basis in acquired assets• Generally avoids dissenters’ appraisal
rights
4
ASSET VS. STOCK DEALS (CONT.)
• Disadvantages• Purchased assets and assumed liabilities must be
identified• Deal documents and process more complex• Seller’s contracts may require consent to
assignment that could be avoided with merger or sale of stock
• Employees are effectively terminated and hired by Buyer
• Assuming Seller is not “flow-through” entity or division, Seller will bear double tax in sale
5
LIABILITY ISSUES
• Successor Liability• Common Law Standards
• General rule: Liabilities do not transfer with assets, but:• de facto merger theory • “Mere continuation” theory
• Federal Law• Employment claims• Environmental claims• Other claims
• Creditor Claims• Foreclosure purchases
• Unknown Liability• Assumption and Allocating Liability
6
REPRESENTATIONS AND WARRANTIES
A risk shifting mechanismthat allocates the risks inherent
in the business (and the transaction) between Buyer and Seller.
7
REPRESENTATIONS AND WARRANTIES (CONT.)
• Purposes• Disclosure and diligence• Closing condition• Tied to purchased assets and assumed liabilities• Value protection through post-closing indemnity
claims
8
REPRESENTATIONS AND WARRANTIES (CONT.)
• Key Representations• Traditional “Fundamental Representations”• Sufficiency of assets• Title to assets in asset deal• Financial statement representation • Events subsequent to last audit or financial statements• Material Contracts• Accounts Receivable/Payable• Inventory• Absence of liabilities• Absence of litigation• Tax Matters• Intellectual Property • Employee representation• Compliance with law• Products Warranty
9
REPRESENTATIONS AND WARRANTIES (CONT.)
• Date Representation Given “as of”• Knowledge and Materiality Qualifications (MAE vs.
material)• “[B]uyer faces a heavy burden when it attempts to invoke a
material adverse effect clause in order to avoid its obligation to close. Many commentators have noted that Delaware courts have never found a material adverse effect to have occurred in the context of a merger agreement. This is not a coincidence. ” (Hexion Specialty Chemicals, Inc. v. Huntsman Corp.)
• Knowledge often limited to identified people vs. “imputed knowledge”
10
DUE DILIGENCE CONSIDERATIONS
• Liabilities • Indebtedness• Third Party Consents• Governmental Consents• Licenses/Permits• Encumbrances• Federal Contracts • Employee Benefits• Environmental• Industry Specific
11
FORMS OF CONSIDERATION
• Cash• Method of Payment• Timing of Payment
• Equity• Stock vs. Other Equity• Contribution Agreement• Capital Accounts• Securities Issues• Successor Liability Concerns
• Promissory Note• Secured vs. Unsecured• Subordinations• Set-off Rights
12
POST-CLOSING CONSIDERATION
• Earnouts• Mechanism to bridge “value gap”• Often source of post-closing dispute
• “converts today’s disagreement over price into tomorrow’s litigation over the outcome.” (Airborne Health Inc. v. Squid Soap LP)
• Drafting issues• Higher on the P+L = less risk and less benefit
• Revenue • EBITDA/Earnings
• Also can use development or other milestones (e.g., drug approval steps for life sciences company)
• Related covenants can constrain post-closing operation of acquired business (Sonoran Scanners, Inc. v. PerkinElmer, Inc.)
13
QUESTIONS
14
DAY 2
15
GETTING TO CLOSING
• Key Closing Conditions• Payoff letters• Releases• Bring-down• No MAE • HSR Waiting Period• No litigation• Ancillary Documents
• Bill of Sale• Other Assignment Documents• Escrow Agreement• Employment Agreements• Others
16
GETTING TO CLOSING (CONT.)
• Transferring IP• Cincom Systems Inc. v. Novelis Corp.
• “[I]n the context of intellectual property, a license is presumed to be non-assignable and nontransferable in the absence of express provisions to the contrary.”
• “Simply put, in the context of a patent or copyright license, a transfer occurs anytime an entity other than the one to which the license was expressly granted gains possession of the license.”
• SQL Solutions v. Oracle• Reverse triangular merger violated a non-assignment clause in a non-exclusive
copyright license
• Meso Scale Diagnostics, LLC v. Roche Diagnostics GMBH• Reverse triangular merger may violate a non-assignment clause that prohibited
assignment by operation of law in a non-exclusive patent license
• Generally• Non-exclusive IP license may not be assigned without licensor’s consent• Split authority on assignability of exclusive IP license without licensor’s consent• Licensor may assign IP license without licensee consent 17
GETTING TO CLOSING (CONT.)
• Transferring Commercial Contracts• Anti-assignment provisions• Novation
• Government Contracts• FAR Novation requirements
• Real Property• Title policies• Mortgages• Surveys• Environmental Review
• Receivables• Securities
• Assignment Instruments• Possession of Security• Lost Securities
18
EMPLOYEE ISSUES
• Seller must terminate and Buyer must offer employment to employees or assume existing obligations
• Depending on the Seller’s existing arrangements, it may be advisable to provide certain key employees with new employment agreements
• Formal employment agreements are typically provided to a limited group of key employees
• Key employees may also be asked to sign noncompetition agreements
• Equity incentives analysis
19
EMPLOYEE ISSUES (CONT.)
• WARN Act – Employers must provide 60 days’ notice (or pay and benefits in lieu of) in event of significant layoffs, including in acquisition context• 50-employee threshold; aggregation of smaller layoffs• Consider impact of state “Mini-WARN” statutes
20
EMPLOYEE ISSUES (CONT.)
• COBRA Health Insurance Continuation• Federal right to obtain continued health insurance coverage at own
expense when loss of employment leads to loss of coverage• 20-employee threshold• Parties in a transaction are free to negotiate responsibility to provide
notices and coverage• Regardless of parties’ agreement, IRS rules shift obligation to Buyer in asset
transactions where Seller discontinues health plan• As a result, a Buyer can end up with the obligation to cover employees
already on COBRA at time of transaction (who never worked for Buyer)• Provision of required notices is key; COBRA is an adverse selection regime,
and failure to provide notice can give employees a “second bite at the apple.”
• Consider state COBRA provisions
21
TAX ISSUES
• Double taxation• Basis Step-up• Income Tax
• Pre-closing• Post-closing• Straddle Period
• Real Property Transfer Taxes• General Transfer Taxes• Bulk Sales Taxes• Sales/Use Tax• Post-closing Filings• Benefits of Transaction Expense Deduction
22
TAX ISSUES (BULK SALES)
• General rule in most states: A Buyer in a “bulk sale” must withhold from the purchase price an amount equal to the Seller’s unpaid sales tax liability or else can be liable for those unpaid liabilities of the Seller
• Many states have bulk sale notice procedures, which vary by state• Under those notice procedures, the Buyer in a bulk sale transaction
usually provides advance notice to the state of the impending acquisition
• The state then notifies the Buyer of how much unpaid sales tax is owed by the Seller that should be withheld out of the purchase price.
• State response times to notices also vary significantly (as little as 10 days, sometimes up to 6 months), and this can hold up a closing or require that funds be placed in escrow
23
POST-CLOSING ISSUES
• Continuation Covenant • Fraudulent Conveyance
• Representation• Capitalization covenant
• Equity holders of Seller agree to assume Seller’s obligations after termination of existence
• Seller name change• Seller’s bank accounts• Wrong-pocket covenant
24
POST-CLOSING ISSUES (CONT.)
• Escrow/Holdback• Source of post-closing recourse for purchase price
adjustment and indemnities• Typical range of 5% - 20%. Mean and median about 10%
• Typically available during survival period for general reps and warranties (12 – 24 months)• Although escrow period often shorter (12 months)
• Potential for staged release• Usually not sole source of recourse for all claims• Consider side pocket escrow for purchase price
adjustments and special indemnities
25
POST-CLOSING ISSUES (CONT.)
• Indemnification• Drafted to provide remedies greater than common law breach of
contract• Indemnifying Party - may want to look past the selling entity to
principal stockholders if only a shell is left post-transaction• Who pays?
• Collecting money beyond escrow presents practical as well as legal difficulties• Guarantees
• Key Concepts• Cap• Deductible/Basket• Materiality Scrape• Sandbagging• Exclusive remedy• Joint vs. Several
26
QUESTIONS
27
IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
MESO SCALE DIAGNOSTICS, LLC, ) MESO SCALE TECHNOLOGIES, LLC, ) )
Plaintiffs, ) ) v. ) C.A. No. 5589-VCP ) ROCHE DIAGNOSTICS GMBH., ) ROCHE DIAGNOSTICS CORP., ) ROCHE HOLDING LTD., ) IGEN INTERNATIONAL, INC., ) IGEN LS LLC, ) LILLI ACQUISITION CORP., ) BIOVERIS CORP., ) ) Defendants. )
MEMORANDUM OPINION
Submitted: December 10, 2010 Decided: April 8, 2011
Collins J. Seitz, Jr., Esq., Arthur G. Connolly, III, Esq., Ryan P. Newell, Esq., CONNOLLY BOVE LODGE & HUTZ, LLP, Wilmington, Delaware; Mark C. Hansen, Esq., Michael J. Guzman, Esq., Christopher J. Walker, Esq., KELLOGG, HUBER, HANSEN, TODD, EVANS & FIGEL, P.L.L.C., Washington, D.C.; Attorneys for Plaintiffs Meso Scale Diagnostics, LLC and Meso Scale Technologies, LLC.
Andre G. Bouchard, Esq., Sean M. Brennecke, Esq., BOUCHARD MARGULES & FRIEDLANDER, P.A., Wilmington, Delaware; Nancy J. Sennett, Esq., Paul Bargren, Esq., Eric L. Maassen, Esq., FOLEY & LARDNER, LLP, Milwaukee, Wisconsin; Attorneys for Defendants.
PARSONS, Vice Chancellor.
EFiled: Apr 8 2011 2:23PM EDT Transaction ID 36939602 Case No. 5589-VCP
1
This case arises out of a series of agreements between the parties to this action
relating to, among other things, license rights to use electrochemiluminescence (“ECL”)
technology. After losing its original nonexclusive license to use this technology,
Defendant Roche Holding Ltd. (“Roche”)1 sought to reacquire an ECL license from then-
patent holder, Defendant IGEN International, Inc. (“IGEN”).2 In 2003, as part of a
complicated transaction comprised of a dozen or so contemporaneously executed
agreements (the “Transaction”), Roche obtained a second nonexclusive license from
IGEN. Plaintiffs, Meso Scale Diagnostics, LLC (“MSD”) and Meso Scale Technologies
LLC (“MST”) (together with MSD, “Plaintiffs”), explicitly consented to that Transaction.
As part of the Transaction, Roche acquired IGEN, but before it did so, IGEN transferred
all of its intellectual property assets, subject to outstanding license rights, to a newly-
created public corporation, Defendant BioVeris Corporation (“BioVeris”). Later, in
2007, Roche acquired BioVeris in a reverse triangular merger in which BioVeris was the
surviving entity.
In 2010, Plaintiffs filed their Complaint in this action accusing Roche and a
number of its affiliates of breaching provisions in two agreements related to the
Transaction based on, among other things, Roche’s acquisition of BioVeris without
1 Plaintiffs named as Defendants a number of other Roche affiliates, including Roche Diagnostics GmbH, Roche Diagnostics Corp., IGEN, IGEN LS LLC, and Lili Acquisition Corp. Verified Compl. (the “Complaint”) at Introduction. As Plaintiffs do in their Complaint, I refer to these entities collectively as “Roche,” but differentiate among them when necessary.
2 Id. ¶ 9.
2
Plaintiffs’ consent. Roche denies these allegations and has moved to dismiss the
Complaint. For the reasons discussed below, I deny Roche’s motion.
I. BACKGROUND
A. The Parties
MST was founded by Jacob Wohlstadter for the purpose of, among other things,
commercializing his invention of a new application of ECL that enhances its versatility
and cost-effectiveness.3 MSD was formed in 1995 as a joint venture between MST and
IGEN. It employs approximately 350 employees and manufactures, markets, and sells
instruments and kits utilizing its proprietary Multi-Array® ECL technology, particularly
in the spheres of biological research and drug development. MSD also manufactures,
markets, and sells instruments and consumables to the U.S. military for biodefense
testing.
IGEN was a Delaware corporation in the business of developing and marketing
biological detection systems based on its proprietary ECL technology. Its ECL-based
products were used in a number of applications, including pharmaceutical research and
development, life science research, biodefense testing, and testing for food safety and
quality control. As part of the Transaction, Roche purchased IGEN. Roche is a
3 Id. ¶ 9. Unless otherwise noted, all facts recited in this Memorandum Opinion are drawn from the Complaint and accepted as true for purposes of Defendants’ motion to dismiss.
3
preeminent research-focused healthcare conglomerate, which employs approximately
75,000 people worldwide and operates in the pharmaceuticals and diagnostics space.
As discussed further infra, in connection with Roche’s acquisition of IGEN,
BioVeris was created, and it contemporaneously acquired certain of IGEN’s ECL-related
intellectual property as well as IGEN’s rights and obligations as licensor of certain
patents to MSD. Roche acquired BioVeris in 2007.
B. Facts
1. A brief note on ECL
ECL uses electricity, chemistry, and light to detect and measure the presence of
specific molecules in a test sample, including, for example, blood and other bodily fluids.
It is useful to detect and measure amounts of select proteins in these biological samples
and can be used for human patient diagnosis, clinical trials, drug research, and other
similar applications.
2. The 1992 License
In 1992, IGEN entered into a license agreement with Boehringer Manheim GmbH,
a company acquired by Roche in 1998 (the “1992 License”).4 This license granted Roche
an exclusive, but narrow, right to use IGEN’s ECL technology in blood banks, hospitals,
and clinical reference laboratories. Plaintiffs claim that this license did not authorize
Roche to use ECL technology in contexts involving patient contact, such as in
physicians’ offices.
4 For purposes of this Memorandum Opinion, I include Boehringer Manheim GmbH in the term “Roche.”
4
3. The MSD License
In 1995, IGEN and MST entered into a joint venture and formed MSD “to be the
vehicle for developing the venture partners’ ECL-related intellectual property.”5 MST
licensed to MSD certain intellectual property regarding, for example, selection
techniques, multi-array tests, and disposable electrodes, as well as contributed the
services of Wohlstadter. For its part, IGEN entered into a licensing agreement with MSD
(the “MSD License Agreement”), which granted MSD “an exclusive, worldwide, royalty-
free license to practice the IGEN Technology to make, use and sell products or processes
. . .” (the “MSD License”).6 IGEN granted that license based on the rights it retained to
make commercial use of all fields of ECL outside the limited field it had licensed to
Roche in the 1992 License.
The MSD License Agreement granted MSD exclusive rights to certain broadly-
defined ECL fields. They included: (i) various “selection and screening methods;” (ii)
“disposable electrodes;” and (iii) multi-array diagnostic[s].”7 Importantly, the MSD
5 Compl. ¶ 18.
6 Id. ¶ 19 (citing MSD License Agreement § 2.1). The parties allegedly granted MSD exclusive rights to make commercial use of ECL products and processes. MST and IGEN agreed in their Joint Venture Agreement (“JVA”) that neither “shall market directly, or license others to market, products that compete with MSD with respect to [products, processes, and services MSD developed].”). SeeCompl. ¶ 18 (citing JVA § 4.1).
7 Id. ¶ 21 (citing JVA § 1.11). The exclusive technologies “specifically include, but are not limited to, monolayers, molecular assemblies . . . multi-array and/or multi-specific surfaces, electrochromics, microelectrodes,” and other technologies. Seeid.
5
License Agreement provides that these license rights could expand over time in at least
two respects. In particular, MSD’s ECL rights would expand as and to the extent MSD
conducted new research8 and in the event that any of IGEN’s previous third-party ECL
exclusive licenses were terminated or became nonexclusive. In the latter case, the
effected rights would be licensed to MSD, and not revert to IGEN.9
4. The Fourth Circuit litigation
In 1997, IGEN brought suit in the United States District Court for the District of
Maryland, alleging, among other things, that Roche violated the field restrictions in the
1992 License from IGEN.10 While the details of this suit are not germane here, its
consequences are. After trial, the jury returned a special verdict in favor of IGEN on
each of its claims, including that Roche had materially breached the 1992 License, and
awarded IGEN compensatory and punitive damages.11 In 2003, the Court of Appeals for
the Fourth Circuit significantly reduced the damages award, but affirmed the jury’s
finding that Roche breached the 1992 License by marketing ECL-based products outside
8 See id. The parties provided that the MSD License would be perpetual and survive the termination of the JVA. See id. ¶ 19 (citing JVA § 6.1).
9 Section 2.1 of the MSD License Agreement states, “in the event any such exclusive license terminates, or IGEN is otherwise no longer restricted by such license from licensing such technology to MSD, such technology shall be, and hereby is, licensed to MSD pursuant hereto.”
10 For the factual and procedural history of this case, see IGEN Int'l, Inc. v. Roche Diags. GmbH, 335 F.3d 303 (4th Cir. 2003).
11 See id. at 308. The district court denied Roche’s post-trial motions for judgment as a matter of law, a new trial, and reduction of the punitive damages award. Id.
6
of its permitted field.12 As a result, the court permitted IGEN to terminate the 1992
License and Roche’s rights to use IGEN’s ECL technology thereunder.
5. The Transaction
Faced with the imminent loss of its ECL license rights upon the Fourth Circuit’s
ruling, Roche sought to reacquire those rights so as not to disrupt its immunoassay
business, for which ECL technology is a necessary component. Consequently, within
two weeks of the appellate ruling, Roche arranged a solution to preserve its ability to use
IGEN’s ECL technology. Specifically, Roche purchased IGEN for $1.25 billion and, in
addition, it, along with IGEN, MSD, and MST, entered into the Transaction, which is
embodied in a series of contemporaneous agreements (the “Transaction Agreements”).13
Importantly, Roche did not seek to purchase IGEN’s full portfolio of ECL patents
nor its interest in the MSD joint venture. Rather, it sought a license to use ECL
technology in a limited field of individual patient human diagnostics. In fact, the parties
excluded IGEN’s ECL-related patents and interest in MSD from Roche’s purchase of
IGEN. In addition, they created “BioVeris, a publicly traded company not affiliated with
Roche and which had the same management and owners as IGEN, to obtain IGEN’s ECL
12 IGEN Int'l, Inc., 335 F.3d at 315.
13 See Compl. Ex A, the Global Consent Agreement (“Global Consent”), § 1.01.
7
intellectual property, its rights to the Roche License, its rights to the MSD License, and
its obligations under the Joint Venture.”14
The mechanics of the Transaction worked as follows. IGEN provided a license to
IGEN LS LLC (the “Roche License” or “License”), a wholly-owned subsidiary of IGEN
created solely to obtain that license. IGEN then assigned to BioVeris the remainder of its
assets, rights, and interests, including its ECL patents, as well as its contractual rights and
obligations as a member in and licensor to MSD. BioVeris also acquired IGEN’s rights
and obligations as licensor of the 2003 Roche License. Roche then indirectly acquired
IGEN LS LLC, the licensee under the Roche License, by acquiring IGEN, its parent, in
exchange for $1.25 billion. The net effect of these steps was that Roche obtained its
limited-field license and BioVeris obtained the remainder of IGEN’s intellectual property
assets, including its ECL patents and licensor rights and obligations under the Roche and
MSD Licenses.
As noted, the parties executed numerous subsidiary agreements in order to
implement the Transaction. Of them, the most relevant to this action are the Roche
License and the Global Consent. I address each of those documents in turn.
6. The Roche License
Through the Roche License, Roche obtained “only for use in the Field, an
irrevocable, perpetual, Non-Exclusive, worldwide, fully-paid, royalty-free right and
14 Compl. ¶ 28. As the Complaint notes, BioVeris, MST, and MSD agreed to terminate the Joint Venture. Id. at n.6. In December 2004, MST exercised its right to purchase BioVeris’s share of MSD. Id.
8
license under the Licensed ECL Technology, to develop . . . use, . . . sell, . . . and
otherwise commercially exploit Products.”15 Because the license is nonexclusive, the
licensor, IGEN and then BioVeris, “may during the Term of [the Roche License] exercise
the licensed rights itself in the licensee’s field or grant non-exclusive licenses in the
licensee’s field to a third party, or retain for itself any non-exclusive license rights.”16
The License defined the term “Field” to mean “the analyzing of specimens taken from a
human body, including without limitation, blood, bodily fluid or tissue, for the purpose of
testing, with respect to that human being, for a physiological or pathological state, a
congenital abnormality, safety and compatibility of a treatment or to monitor therapeutic
measures.”17
The Roche License limited severely Roche’s ability to market ECL products
outside the Field. Indeed, IGEN LS LLC, and indirectly Roche, covenanted that it would
“not, under any circumstances, actively advertise or market the Products in fields other
15 Compl. Ex. B, Roche License Agreement, § 2.1. “Products” is defined as “ECL instruments, service for ECL instruments and spare parts; and ECL Assays.” Id. § 1.13.
16 Id. § 1.10.
17 Id. § 1.7(a). The Roche License limits the Field by stating that, “Notwithstanding [subsection (a)], the Field shall not include analyzing for (A) life science research and/or development, including at any pharmaceutical company or biotechnology company, (B) patient self testing use; (C) drug discovery and/or drug development . . . including clinical research or determinations in or for clinical trials or in the regulatory approval process for a drug or therapy, or (D) veterinary, food, water, or environmental testing or use.” Id. § 1.7(b) (inconsistent punctuation in original).
9
than those in the Field.”18 In addition, § 2.5(a) of the Roche License contemplated that a
neutral third party would monitor Roche’s sales, at least annually, to track its compliance
with its obligations regarding marketing its products within the Field.19 Section 2.5(b)
provided some teeth to this prohibition by requiring Roche to pay to the licensor, within
30 days of having received a notice from the licensor that it is operating outside of the
Field, “65% of all undisputed revenues [it] earned through out-of-field sales of Products
for the prior year.”20 The License, however, provided that this revenue penalty would be
the licensor’s “exclusive remedy” for out-of-field sales by Roche and that the licensor has
“no right to terminate” the Roche License for such sales.21 Furthermore, if a dispute
should arise between the parties that cannot be resolved in good faith out of court, Article
6 prescribes arbitration as the sole means of dispute resolution.22
Notably, § 14.11 of the License states that, with certain limited exceptions,
“nothing [in the Roche License] is intended to confer upon any person other than the
Parties hereto and their respective successors and permitted assigns, any benefit, right or
18 Id. § 2.6. Moreover, Roche, through IGEN LS LLC, was required to market and sell its products to customers it “reasonably believe[d], based on prior knowledge of and experience with such customer . . . without a duty to inquire or investigate, will use the Products solely in the Field . . . .” Id. § 2.5(c).
19 Id. § 2.5(a).
20 Id. § 2.5(b).
21 Roche License Agreement § 2.5(b).
22 Id. §§ 6.1-6.3.
10
remedy under or by reason of [the Roche License].”23 The License explicitly designates
IGEN and IGEN LS LLC as the sole “Parties” to the agreement.24 But, immediately
following the signature page, Plaintiffs MSD and MST signed a form entitled
“CONSENT BY MESO SCALE DIAGNOSTICS, LLC AND MESO SCALE
TECHNOLOGIES, LLC” (the “Meso Consent”).25 That document indicates that
together, Plaintiffs
consent[ed] to the [Roche License] . . . and . . . consent[ed] to and join[ed] in the licenses granted to [Roche] in the [Roche License]. . . . Furthermore, MSD and MST . . . represent[ed] and warrant[ed] to [Roche] that each of them . . . waive[d] any right that either of them may have to in any way restrict or limit [Roche]’s exercise of the licenses granted in the [Roche License] during the Term thereof.26
Plaintiffs contend that Roche sought Plaintiffs’ consent at a price of $37.5 million
because Roche was concerned that IGEN, by virtue of the rights it previously granted to
MSD through the MSD License, might not be able to grant unilaterally the rights Roche
sought under the Roche License without violating the MSD License.27 Indeed, Plaintiffs
23 Id. § 14.11.
24 Id. at 1.
25 Id. at Meso Consent (following signature page).
26 Id.
27 Pls.’ Opp. to Defs.’ Mot. to Dismiss (“PAB”) 10-11. Similarly, I refer to Defendants’ opening brief as “DOB” and their reply brief as “DRB.”
Plaintiffs allege in their brief that MSD’s rights under the MSD License had expanded since 1995 because, among other things, MSD received Roche’s rights to market Products in the field described in the 1992 License, pursuant to MSD’s
11
argue that, pursuant to § 4.1 of the JVA, IGEN could not have licensed Roche to compete
with MSD, as the Roche License purports to permit, absent the consent of MSD and
MST. Moreover, they assert that Roche also needed MSD to consent affirmatively to the
rights offered to Roche under the Roche License based on the springing nature of the
MSD License, under which MSD’s rights could expand by, for example, the acquisition
of rights licensed to Roche under the 1992 License that were to revert to MSD upon its
termination.28 Thus, according to Plaintiffs, Roche chose to pay Plaintiffs to consent to
and join in the Roche License. Plaintiffs assert that Roche received the benefit of MSD
and MST having waived potential claims that the Roche License violated the scope of the
MSD License or their rights under the JVA. In exchange, they aver that MSD and MST
received a cash payment and meaningful protection in the form of § 2.5 and other
provisions in the Roche License that confined Roche to operating in the Field so as to
avoid encroaching on MSD’s exclusive use of ECL technology in other fields.
7. The Global Consent
Also as part of the Transaction, Plaintiffs, Roche, IGEN, and BioVeris entered into
a Global Consent and Agreement (the “Global Consent”), which, among other things,
provided that the parties consented to the “Transaction Agreements and the
“springing rights,” when that agreement was terminated following the Fourth Circuit’s ruling in 2003. See id. at 9-10 (citing Compl. ¶¶ 26, 38). It is unclear, however, from the allegations in the Complaint whether the Transaction, including the new Roche License, actually closed before the 1992 License was terminated.
28 Transcript of Dec. 15, 2010 Argument (“Tr.”) 52-53.
12
consummation of the Transactions” and “grant[ed] all waivers and consents which are
necessary under the MSD Agreements to permit the consummation of the Transactions
and the performance by [IGEN, BioVeris], and each Consenting Party of their obligations
under the Transaction Agreements in accordance with their terms.”29 Specifically, the
parties consented to the aspect of the Transaction whereby BioVeris was created to obtain
IGEN’s assets subject to the license rights held by Plaintiffs.30 The recitals reflect that
the parties simultaneously were entering into a number of separate but related
agreements, including the Merger Agreement, pursuant to which a Roche affiliate merged
with IGEN, and a Restructuring Agreement, under which IGEN transferred its remaining
intellectual property assets to BioVeris.31
29 Global Consent § 3.01.
30 BioVeris initially was named IGEN Integrated Healthcare, LLC and was referred to throughout the Global Consent as “Newco.” Global Consent 1; Compl. ¶ 28. In addition, the parties mutually released each other from any and all past claims arising out of, among other things, contracts, covenants, and agreements up to the effective time of the merger between IGEN and Roche’s subsidiary. See Global Consent § 4.1.
31 Global Consent 1. Section 1.01 of the Global Consent defines “Transactions” as the “transactions contemplated by [the Global Consent] and the other Transaction Agreements.” Id. § 1.01. The “Transaction Agreements” are defined to include: (1) the Global Consent and Agreement; (2) the Merger Agreement; (3) the Restructuring Agreement; (4) the Post-Closing Covenants Agreement; (5) the Tax Allocation Agreement; (6) the Ongoing Litigation Agreement; (7) the Release and Agreement dated July 24, 2003; (8) the Roche License Agreement; (9) the Improvements License Agreement; (10) the Covenants Not to Sue; (11) the PCR License Agreement; and (12) the PCR Services Agreement. Id.
13
As to the asset transfer from IGEN to BioVeris, IGEN assigned all of its assets to
BioVeris, including its ECL patents, production facilities, and contract rights and
obligations. The latter category included the MSD License, the JVA, and IGEN’s interest
in the Roche License granted to IGEN LS LLC.32 Each party to the Global Consent,
including MST and MSD, “consent[ed] to and accept[ed] the assumption by [BioVeris]
of all the rights, obligations, duties and Liabilities . . . of [IGEN] under the MSD
Agreements . . . and agree[d] to perform [their] obligations, duties, [and] Liabilities . . .
under the MSD Agreements in accordance with their terms in favor of [BioVeris].”33
Schedule A lists a number of subsidiary agreements that comprise the “MSD
Agreements,” including the JVA and the MSD License.34 Section 3.02(e) provides that,
except for the rights of IGEN LS LLC (i.e., Roche) under the Roche License, BioVeris
will own “all right, title and interest in and to any and all intellectual property and other
proprietary and confidential information or materials owned by [IGEN] as of the date
hereof.”35
In addition, the Global Consent contains a nonassignment clause that is a focal
point of this dispute. Section 5.08 provides:
Neither this Agreement nor any of the rights, interests or obligations under [it] shall be assigned, in whole or in part, by
32 See id. §§ 3.01-3.02.
33 Id. § 3.02(b).
34 Id. at Schedule A; Compl. ¶ 36.
35 Global Consent § 3.02(e).
14
operation of law or otherwise by any of the parties without the prior written consent of the other parties; provided, however, that the parties acknowledge and agree that the conversion of [BioVeris] in accordance with Section 2.01 of the Restructuring Agreement and the continuation of [BioVeris] as a result thereof shall be deemed not to be an assignment and shall not require any consent of any party. Any purported assignment without such consent shall be void. Subject to the preceding sentences, this Agreement will be binding upon, inure to the benefit of, and be enforceable by, the parties and their respective successors and assigns.36
As discussed further infra, Plaintiffs allegedly were concerned that “Roche might
someday seek to purchase BioVeris and its ECL-related intellectual property in an
attempt to expand its ECL activities beyond the Field.”37 According to Plaintiffs, they
negotiated for the right under § 5.08 to consent to any purchase of BioVeris going
forward to protect them from this threat.
8. Roche’s acquisition of BioVeris in 2007
After the Transaction closed in 2004, a dispute arose between Roche and BioVeris
concerning allegations that Roche was selling ECL-based products outside of its Field.
According to Plaintiffs, Roche believed its violation of the Field restrictions amounted to
only a few million dollars for the years 2004 and 2005, and offered to pay these amounts
as royalty fees to BioVeris. BioVeris allegedly believed, however, that Roche’s
violations amounted to a figure “on the order of hundreds of millions of dollars.”38 In
36 Id. § 5.08 (emphasis in original).
37 Compl. ¶¶ 35-36.
38 Id. ¶ 43.
15
November 2006, BioVeris demanded full payment of royalties owed and invoked its
contractual right for an accounting of Roche’s activities by a neutral monitor,
PriceWaterhouseCoopers. Within a few weeks, Roche approached BioVeris with an
offer to purchase the company. The two entities then began approximately five months
of negotiations, culminating in an April 2007 announcement of a transaction whereby
Roche would acquire a 100% interest in BioVeris in exchange for $21.50 per share in
cash, a total deal value of approximately $600 million (the “BioVeris Merger”).39
The BioVeris Merger was effected pursuant to the “Agreement and Plan of Merger
dated as of April 4, 2007 among Roche Holding Ltd., Lili Acquisition Corporation
[“LAC”], and BioVeris Corporation” (the “BioVeris Merger Agreement”).40 The
mechanics of this reverse triangular merger worked as follows. Roche Holding Ltd.
created LAC as a wholly-owned subsidiary, which then merged into BioVeris, with
BioVeris as the surviving corporation.41 BioVeris stockholders were paid cash for their
shares and, as a result of the Merger, Roche became the sole stockholder of BioVeris.
The effect of the Merger was that “all properties, rights, privileges, powers and franchises
of [BioVeris] and [LAC] [vested] in [BioVeris], and all claims, obligations, debts,
39 The BioVeris Merger closed on June 26, 2007. Id. ¶ 50.
40 Compl. Ex. E.
41 BioVeris Merger Agreement §§ 1.1, 1.4.
16
liabilities and duties of [BioVeris] and [LAC] [became] the claims, obligations, debts,
liabilities and duties of [BioVeris].”42
Plaintiffs allege that Roche purchased BioVeris solely to obtain the latter’s ECL-
related intellectual property rights, including its ownership rights under the Roche and
MSD Licenses. They further assert that, within months of the BioVeris Merger, Roche
laid off all of its approximately 200 employees, vacated the BioVeris facility in
Maryland, and notified existing customers that BioVeris’s product lines were being
discontinued, leaving BioVeris as nothing more than a holding company for its
intellectual property and license rights.
C. Procedural History
On June 22, 2010, Plaintiffs filed their Complaint alleging two counts for breach
of contract as to (1) the Global Consent and (2) the Roche License. On September 2,
2010, Defendants moved to dismiss. After full briefing, I heard argument on December
15, 2010 (the “Argument”). This Memorandum Opinion constitutes my ruling on
Defendants’ motion.
D. Parties’ Contentions
Count I of the Complaint accuses Defendants of breaching § 5.08 of the Global
Consent. Plaintiffs contend that, pursuant to § 3.02(e) of that agreement, BioVeris owned
any and all property IGEN owned before its acquisition by Roche in the Transaction.
They assert that, pursuant to § 5.08, BioVeris could not assign this property, by operation
42 Id. § 1.4.
17
of law or otherwise, without the written consent of MSD and MST. Essentially,
according to Plaintiffs, these provisions required Roche and BioVeris to obtain written
consent from MSD and MST to permit any assignment by BioVeris to Roche of its rights,
interests, and obligations in or to IGEN’s intellectual property, including the Roche and
MSD Licenses. Thus, they argue that Defendants breached § 5.08 because they did not
obtain the consent of MSD or MST when Roche acquired BioVeris in a transaction that
Plaintiffs contend constituted an assignment of BioVeris’s intellectual property by
operation of law or otherwise.
Count II alleges that Roche breached provisions of the Roche License. In
particular, it alleges that, notwithstanding Roche’s acquisition of BioVeris in 2007,
Roche’s covenants to MSD and MST under the Roche License precluded it from
marketing and selling ECL-based products outside of the Field.
Roche contends that Plaintiffs have failed to state a claim on both Counts. As to
Count I, Roche asserts that § 5.08 does not apply to the patents and licenses BioVeris
obtained from IGEN in the Transaction and, even if it does, Roche’s acquisition of
BioVeris through a reverse triangular merger was not prohibited by that provision
because no property was assigned from BioVeris to Roche. As to Count II, Roche argues
that Plaintiffs cannot prevail on their claims under the Roche License if they do not
prevail on Count I. Regardless, Roche avers that Plaintiffs cannot state a claim for
breach of the Roche License for two additional reasons: (1) neither Plaintiff was a party
to that license nor obtained third party rights thereunder so they have no standing to
assert its breach; and (2) even if Plaintiffs had rights under the Roche License, its Field
18
limitations ceased to be of effect once Roche acquired BioVeris and the latter’s ECL
patents and other intellectual property.
Plaintiffs vigorously dispute Roche’s characterizations of the Complaint and
contend that they have sufficiently stated a claim under each of the challenged counts.
II. ANALYSIS
A. Standard for a Motion to Dismiss
When considering a motion to dismiss under Rule 12(b)(6), a court must assume
the truthfulness of the well-pleaded allegations in the complaint and afford the party
opposing the motion “the benefit of all reasonable inferences.”43 But, the court need not
accept inferences or factual conclusions unsupported by specific allegations of fact.44
Consequently, to survive a Rule 12(b)(6) motion, a complaint must allege facts sufficient
to support a reasonable inference of actionable conduct, not simply a conclusion to that
effect.45 In line with the standard articulated by the United States Supreme Court in Bell
Atlantic v. Twombly,46 the court must determine whether the complaint offers sufficient
facts plausibly to suggest that the plaintiff ultimately will be entitled to the relief she
43 Superwire.com, Inc. v. Hampton, 805 A.2d 904, 908 (Del. Ch. 2002) (citing In re USACafes, L.P. Litig., 600 A.2d 43, 47 (Del. Ch. 1991)).
44 Ruffalo v. Transtech Serv. P’rs Inc., 2010 WL 3307487, at *10 (Del. Ch. Aug. 23, 2010).
45 Desimone v. Barrows, 924 A.2d 908, 928-29 (Del. Ch. 2007).
46 Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555-56 (2007).
19
seeks.47 “If a complaint fails to do that and instead asserts mere conclusions, a Rule
12(b)(6) motion to dismiss must be granted.”48
B. Application to Counts I and II
1. Applicable principles of contract interpretation
The interpretation of a contract is a question of law and, in many cases, is suitable
for determination on a motion to dismiss.49 When interpreting a contract, the Delaware
courts strive to determine the parties' shared intent, “looking first at the relevant
document, read as a whole, in order to divine that intent.”50 As part of that review, the
court interprets the words “using their common or ordinary meaning, unless the contract
47 Desimone, 924 A.2d at 928-29.
48 Ruffalo, 2010 WL 3307487, at *10 (citing Desimone, 924 A.2d at 929). In considering a motion to dismiss for failure to state a claim, a court generally may not consider matters beyond the complaint. See Robotti & Co. v. Liddell, 2010 WL 157474, at *5 (Del. Ch. Jan. 14, 2010). A court may consider, however, a document beyond the complaint on a motion to dismiss if the proponent establishes that such document is either “[1] integral to, and incorporated within, the plaintiff’s complaint; or . . . [2] not being relied upon for the truth of [its] contents.” Id.; see also Vanderbilt Income & Growth Assocs., L.L.C. v. Arvida/JMB Managers, Inc., 691 A.2d 609, 613 (Del. 1996); Liddell, 2010 WL 157474, at *5; Addy v. Piedmonte, 2009 WL 707641, at *6 (Del. Ch. Mar. 18, 2009). Consistent with those principles, I have considered on Defendants’ motion the Roche License Agreement, the Global Consent, and the BioVeris Merger Agreement because they are integral to and incorporated in the Complaint.
49 See, e.g., Schuss v. Penfield P’rs, L.P., 2008 WL 2433842, at *6 (Del. Ch. June 13, 2008); OSI Sys., Inc. v. Instrumentarium Corp., 892 A.2d 1086, 1090 (Del. Ch. 2006).
50 Schuss, 2008 WL 2433842, at *6.
20
clearly shows that the parties’ intent was otherwise.”51 Moreover, when interpreting a
contractual provision, a court should attempt to reconcile all of the agreement's
provisions when read as a whole, giving effect to each and every term. In doing so, this
Court applies the well-settled principle that “contracts must be interpreted in a manner
that does not render any provision ‘illusory or meaningless.’”52
If the contractual language at issue is “clear and unambiguous,” the ordinary
meaning of the language generally will establish the parties’ intent.53 To demonstrate
that a contract is ambiguous, a litigant must show that the language “in controversy [is]
reasonably or fairly susceptible of different interpretations or may have two or more
different meanings.”54 Furthermore, on a motion to dismiss, a trial court cannot choose
between two different reasonable interpretations of an ambiguous document.55 Thus,
51 Cove on Herring Creek Homeowners' Ass'n v. Riggs, 2005 WL 1252399, at *1 (Del. Ch. May 19, 2005) (quoting Paxson Commc'ns Corp. v. NBC Universal, Inc., 2005 WL 1038997, at *9 (Del. Ch. Apr. 29, 2005)).
52 Schuss, 2008 WL 2433842, at *6 (internal citation omitted).
53 Brandywine River Prop., LLC v. Maffet, 2007 WL 4327780, at *3 (Del. Ch. Dec. 5, 2007).
54 Pharmathene, Inc. v. Siga Techs., Inc., 2008 WL 151855, at *11 (Del. Ch. Jan. 16, 2008) (internal citations omitted). Ambiguity does not exist simply because the parties do not agree on a contract's proper construction. United Rentals, Inc. v. Ram Hldgs., Inc., 2007 WL 4496338, at *15 (Del. Ch. Dec. 21, 2007).
55 See Appriva S'holder Litig. Co. v. EV3, Inc., 937 A.2d 1275, 1289 (Del. 2007).
21
where potential ambiguity exists, “‘[d]ismissal is proper only if the defendants'
interpretation is the only reasonable construction as a matter of law.’”56
2. Count I: Breach of § 5.08 of the Global Consent
Defendants argue that Plaintiffs failed to state a claim for breach of § 5.08 of the
Global Consent. They contend that, by its express terms, § 5.08 does not apply to
BioVeris’s patents and licenses, and even if those patents and licenses were covered, no
assignment in violation of § 5.08 occurred. I address each of these points in turn.57
a. Are rights, interests, or obligations relating to BioVeris’s intellectual property subject to § 5.08 of the Global Consent?
In pertinent part, § 5.08 states:
Neither this Agreement nor any of the rights, interests or obligations under this Agreement shall be assigned, in whole or in part, by operation of law or otherwise by any of the parties without the prior written consent of the other parties; provided, however, that the parties acknowledge and agree that the conversion of [BioVeris] in accordance with Section 2.01 of the Restructuring Agreement and the continuation of [BioVeris] as a result thereof shall be deemed not to be an assignment and shall not require any consent of any party. . . .58
Relying on the opening phrase of the Global Consent, which begins, “GLOBAL
CONSENT AND AGREEMENT (this ‘Agreement’),” Roche argues that the parties
56 Id. (quoting Vanderbilt Income & Growth Assoc. v. Arvida/JMB Managers, Inc., 691 A.2d 609, 613 (Del. 1996)).
57 In doing so, I note that Delaware law governs the construction of the Global Consent. Global Consent § 5.06.
58 Id. § 5.08 (italics in original, bold emphasis added).
22
defined the term “Agreement” to be the Global Consent. From that, it extrapolates that
the plain meaning of “under” in the phrase “under this Agreement” is that the Global
Consent’s nonassignment clause applies only to the rights, interests, and obligations
created or established under the Global Consent, not those created or established under
other contracts. To support this construction, Roche notes that § 5.08 makes no mention
of BioVeris’s patents or licenses and asserts that nothing suggests those intellectual
property rights came into being or otherwise arose “under” the Global Consent.59
Moreover, Roche contends that just because certain provisions in Article 3 of the Global
Consent reference intellectual property rights and interests does not mean those rights and
interests arose under the Global Consent.60
Essentially, Roche argues that, under the plain meaning of § 5.08, for the rights,
interests, and obligations in BioVeris’s patents and licenses to be deemed to be “under”
the Global Consent, they must have been created by the Global Consent.61 Because
59 Roche argues that BioVeris obtained its intellectual property assets from IGEN before the Global Consent was executed, and Roche obtained its license in the separately executed Roche License Agreement. Furthermore, those assets were not transferred from IGEN to BioVeris under the Global Consent; rather, they were transferred pursuant to the separately executed Restructuring Agreement.
60 For example, Roche asserts that, under § 3.02(b), the parties to the Global Consent agreed to transfer certain assets from IGEN to BioVeris so that the “right” created under that provision was the right to transfer those interests, not the interests themselves. DOB 18.
61 Roche contends that the term “under” is unambiguous and, therefore, objects to Plaintiffs’ attempted use of extrinsic evidence about their subjective understanding of its meaning. Id. at 20-22.
23
rights, interests, and obligations relating to those assets arose from contracts executed
earlier or contemporaneously, and not from the Global Consent, Roche asserts that § 5.08
does not restrict assignment of BioVeris’s patents and licenses. According to Roche, if
Plaintiffs wanted to limit the ability of BioVeris to assign its intellectual property assets,
they could have used that language in § 5.08, but chose not to do so.
Assuming, without deciding, that Roche’s construction is reasonable,62 to succeed
on its motion, Roche must demonstrate that its construction of § 5.08 is the only
reasonable interpretation.63 Plaintiffs argue that giving the term “under” its common and
ordinary meaning, § 5.08’s prohibitions on assignment are not limited to rights “created
62 Plaintiffs contend that Roche’s construction is unreasonable because it would render § 5.08 meaningless, making it a nullity. PAB 20-21 (citing O’Brien v. Progressive N. Ins. Co., 785 A.2d 281, 287 (Del. 2001)). They aver that, per Roche’s construction, § 5.08 would cover only Plaintiffs’ consent to the acquisition of IGEN, the creation of BioVeris and transfer of IGEN’s assets to it, and Plaintiffs’ covenant not to interfere with those transactions. According to Plaintiffs, if these were the only rights, interests, or obligations that arose “under” the Global Consent, they would become irretrievable upon the closing of the Transaction and Plaintiffs would have no right to consent thereafter. As such, § 5.08 would be a dead letter after the closing and, therefore, virtually meaningless.
At this preliminary stage, I am not convinced that Roche’s construction would render § 5.08 meaningless. The Transaction Agreements defined in § 1.01 of the Global Consent were executed in July 2003, but the Transaction did not close until February 2004. Thus, according to Roche, § 5.08 prevented the parties from assigning their rights under the Global Consent in the interim. At least arguably, therefore, § 5.08’s prohibition on unauthorized assignment would have some meaning, although it would be of marginal importance.
63 See Pharmathene, Inc. v. Siga Techs., Inc., 2008 WL 151855, at *11 (Del. Ch. Jan. 16, 2008) (noting that a contract is ambiguous where the language at issue is reasonably susceptible to two or more different interpretations.).
24
by” or that “arose” under the Global Consent alone. Rather, Plaintiffs argue that “under”
means “within the grouping or designation of.”64 Using this interpretation, they contend
that § 5.08 incorporates by reference all of the rights, interests, and obligations
concerning the acquisition of IGEN and the formation of BioVeris. Citing references in
Article 3, Plaintiffs aver that rights, interests, and obligations created by other
contemporaneous Transaction documents also would come “under” the Global Consent’s
umbrella.65 Otherwise, according to Plaintiffs, Roche’s construction would render the
term “global” in “Global Consent” meaningless. Finally, Plaintiffs argue that only their
construction comports with their intended purpose in negotiating for § 5.08: to prevent
Roche from interfering with their rights under the MSD License and to prevent transfer of
the ownership of that license to another company.
Roche has not shown that Plaintiffs’ construction of the term “under” is
unreasonable. Section 5.08 prevents the assignment, absent consent, of rights, interests,
and obligations “under” this agreement. It does not, as Roche suggests, contain an
express statement that it is limited to those rights, interests, and obligations that were
“created” by or “arose” under the Global Consent. Hence, although Roche’s construction
may be reasonable, it is not the only reasonable one. Section 3.01 of the Global Consent
64 PAB 18 (citing WEBSTER’S THIRD NEW INT’L DICTIONARY 2487 (2002)).
65 At the Argument, Plaintiffs asserted that the Global Consent “knit[s] together those 12 transaction agreements, and get[s] our consent to it, in essence. It doesn’t, within its four corners, create any rights on its own whatever. It’s a consent.” Tr. 62.
25
confirms that, by signing that document, each party was providing a global consent to
each of the multiple Transaction Agreements and the consummation of each
Transaction.66 Under § 1.01, these defined terms include in their purview the twelve
subsidiary agreements that make up the overall Transaction, including the Global
Consent.67 Thus, the term “under” reasonably could encompass rights, interests, and
obligations that were created under one or more of the other eleven agreements. As such,
a reasonable reading of § 5.08 of the overarching Global Consent is that rights and
interests in IGEN’s intellectual property, including ownership of the MSD License,
which subsequently were transferred to the newly-formed BioVeris in 2003, would be
covered by § 5.08’s prohibition against unauthorized assignments.
The proviso in § 5.08 further supports this conclusion. It states, in pertinent part:
“provided, however, that the parties acknowledge and agree that the conversion of
[BioVeris] in accordance with Section 2.01 of the Restructuring Agreement and the
continuation of [BioVeris] as a result thereof shall be deemed not to be an assignment
and shall not require any consent of any party.”68 Plaintiffs credibly assert that the carve-
out from § 5.08’s consent provision of the transfer of assets from IGEN to BioVeris in
the Restructuring Agreement shows that § 5.08 reasonably could apply to actions
authorized by other Transaction Agreements. The source of the rights, interests, and
66 Global Consent § 3.01.
67 Id. § 1.01.
68 Id. § 5.08 (emphasis in original).
26
obligations concerning the creation of BioVeris was the Restructuring Agreement, not the
Global Consent. Yet, the parties explicitly agreed in § 5.08 that BioVeris’s transition
from an LLC to a publicly traded corporation would not be deemed an assignment by
operation of law or otherwise. It is plausible, therefore, that rights or interests created
under other Transaction Agreements, including the Roche License, would be subject to
the requirements in § 5.08 that they not be assigned without Plaintiffs’ consent.
Because § 5.08 is fairly susceptible to more than one reasonable construction, it is
ambiguous. Moreover, this Court cannot resolve that ambiguity in the context of a
motion to dismiss.69
b. Did the BioVeris Merger constitute an assignment “by operation of law”?
Roche contends that even if the Court finds that BioVeris’s patents and licenses
are “rights, interests, or obligations [that fall] under” § 5.08’s nonassignment clause, the
Court still could dismiss Count I because no assignment in violation of that provision
occurred. According to Roche, a change in control of a continuing corporation, as
occurred here, is not an assignment by operation of law or otherwise. In particular,
Roche argues that BioVeris did not assign anything to Roche in the BioVeris Merger.
BioVeris retains today the licenses and intellectual property it received from IGEN in the
Transaction; the only thing that changed is the ownership of BioVeris.
69 See Appriva S'holder Litig. Co. v. EV3, Inc., 937 A.2d 1275, 1289 (Del. 2007) (noting that a motion to dismiss may not be granted for failure to state a claim if the defendants’ interpretation is not the only reasonable construction as a matter of law).
27
It is plausible that § 5.08 does not require Plaintiffs’ consent for all changes in
ownership or control of BioVeris. The relevant language states: “Neither this Agreement
nor any of the rights, interests or obligations under this Agreement shall be assigned, in
whole or in part, by operation of law or otherwise by any of the parties without the
prior written consent of the other parties . . . .”70 This language, on its face, covers
“assignments” and does not expressly prohibit a change of “control” or “ownership” of
BioVeris.71 Nevertheless, the absence of a “change of control provision” in the Global
70 Global Consent § 5.08 (bold emphasis added).
71 Anti-assignment provisions generally provide that the rights and interests under a contract may not be assigned without the consent of the counterparty to the contract. See E. THOM RUMBERGER, JR., ET AL., THE ACQUISITION AND SALE OF
EMERGING GROWTH COMPANIES: THE M&A EXIT, § 5:6 (2d ed. 2009). A typical “anti-assignment” provision states that an “Agreement may not be assigned by either party without the prior written consent of the other party.” See id. (emphasis in original omitted). “A ‘change in control’ provision, on the other hand, typically provides that the counterparty may terminate the contract if target experiences a change in control in its ownership.” Id. Such a provision might state: “Licensor may terminate this Agreement upon thirty calendar days' written notice if Licensee experiences a Change in Control. A ‘Change in Control’ shall mean (i) an acquisition of Licensee by means of a merger, consolidation, share exchange, or other similar transaction or series of related transactions resulting in the exchange of the outstanding shares of Licensee's capital stock such that the stockholders of Licensee prior to such transaction do not own, directly or indirectly, at least fifty percent of the voting power of the surviving entity in the same proportions, relative to other stockholders, as they did prior to such transaction, or (ii) the disposition by sale, license or otherwise of all or substantially all of the assets of Licensee.” Id. (emphasis in original omitted). Thus, when a contract includes this sort of language, third party consent is necessary if the entity is being sold outright or is selling substantially all of its assets. Id.
28
Consent does not necessarily mean that the BioVeris Merger falls outside the scope of §
5.08.
Section 5.08 prohibits, sans consent from MSD and MST, an assignment of
BioVeris’s rights and interests by operation of law or otherwise. That is, if the BioVeris
Merger properly is found to be an assignment by operation of law, it would violate §
5.08, even if that provision did not expressly prohibit unauthorized mergers generally.
Although both Plaintiffs and Roche characterize the term “by operation of law” in § 5.08
as unambiguous, they advance quite different constructions of it. One major difference
relates to whether a reverse triangular merger (“RTM”) could ever be viewed as an
assignment by operation of law. No Delaware case squarely has addressed that issue.
Roche contends that acquisitions of companies owning technology licenses that
are effected by RTMs do not involve assignments “by operation of law.” It argues that
the mere acquisition of a corporation does not involve the assignment by operation of law
of the rights and obligations of that corporation, so long as the corporation’s form and
contractual responsibilities are preserved. Roche begins by emphasizing that the
BioVeris Merger was effectuated through the use of an RTM, whereby BioVeris became
a wholly-owned subsidiary of Roche by having another Roche subsidiary merged into it.
Then, analogizing to cases involving stock acquisitions, Roche contends that the effect on
the surviving entity in an RTM is similar to the effect on an entity whose stock is
purchased in a stock acquisition; that is, the identity of the owners change, but none of
the entity’s contractual responsibilities are varied, or, by implication, assigned.
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Triangular mergers are common and have a myriad of legitimate justifications.72
In an RTM, a parent corporation creates a wholly-owned merger sub and then causes it to
merge into the target. The outstanding shares of the sub, which are owned by the parent,
are converted into shares of the target and the outstanding shares of the target are
converted into shares of the parent or some other consideration.73 An advantage of this
structure is that the target becomes a wholly-owned subsidiary of the parent without
incurring any change in its corporate existence.74 Consequently, “the rights and
obligations of [the target] . . . are not transferred, assumed, or affected. For example,
obtaining consents for the transfer of . . . licenses may not be necessary, absent a
provision to the contrary in the license[] . . . since the license[] will continue to be held by
the same continuing corporation.”75
In making its argument, Roche combines these principles with Delaware’s stock
acquisition jurisprudence. In a number of cases, courts in this State and elsewhere have
held that “[w]here an acquiror purchases the stock of a corporation, that purchase does
72 See Lewis v. Ward, 2003 WL 22461894, at *4 & n.18 (Del. Ch. Oct. 29, 2003), aff'd, 852 A.2d 896 (Del. 2004).
73 1 R. Franklin Balotti & Jesse A. Finklestein, The Delaware Law of Corporations and Business Organizations § 9.8, at 9-11-12 (3d ed. 1998).
74 Id.
75 Id. Pursuant to 8 Del. C. § 259(a), the effect of a merger is that all “the rights, privileges, powers and franchises of each of [the constituent] corporations, and all property, real, personal and mixed, and all debts due to any of said constituent corporations on whatever account . . . shall be vested in the corporation surviving or resulting from such merger or consolidation.” 8 Del. C. § 259(a).
30
not, in and of itself, constitute an ‘assignment’ to the acquiror of any contractual rights or
obligations of the corporation whose stock is sold.”76 This is so because “a purchase or
change of ownership of such securities (again, without more) is not regarded as assigning
or delegating the contractual rights or duties of the corporation whose securities are
purchased.”77
As some commentators have noted, the effect of an RTM is closer to that of a
stock acquisition than it is to a forward triangular merger (“FTM”), where the target
company is not the surviving entity and its rights, interests, and obligations vest in the
surviving entity.78 Like in a stock acquisition, the surviving entity in a typical RTM
76 See, e.g., Baxter Pharm. Prods., Inc. v. ESI Lederle Inc., 1999 WL 160148, at *5 (Del. Ch. Mar. 11, 1999); Branmar Theatre Co. v. Branmar, Inc., 264 A.2d 526, 529 (Del. Ch. 1970) (“Defendant suggests that since ‘the Rappaports' could not assign the lease without its consent they should not be permitted to accomplish the same result by transfer of their stock. But the rule that precludes a person from doing indirectly what he cannot do directly has no application to the present case. The attempted assignment was not by the Rappaports but by plaintiff corporation, the sale of stock by its stockholders. Since defendant has failed to show circumstances to justify ignoring the corporation's separate existence reliance upon the cited rule is misplaced.”).
77 Baxter Pharm. Prods., Inc., 1999 WL 160148, at *5 (emphasis added).
78 See Elaine D. Ziff, The Effect of Corporate Acquisitions on the Target Company's License Rights, 57 BUS. LAW. 767, 788 (2002) (“A reverse subsidiary merger is arguably more analogous to a sale of stock than it is to a forward subsidiary merger where the target company disappears. In a reverse subsidiary merger, when the ‘dust cleared,’ nothing has changed but the ownership of the licensee. Cases involving the effect of stock sales on the target company's license rights have . . . overwhelmingly found that no transfer has occurred.”) (footnotes omitted); cf. In re Inergy L.P., 2010 WL 4273197, at *11 (Del. Ch. Oct. 29, 2010) (“In the corporate context, a parent corporation can acquire a target corporation by setting up a subsidiary to merge with the target—a practice frequently referred to as a
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emerges from the transaction with the same contractual rights and obligations as it had
before the transaction. That is, the target is still the entity obligated to perform under its
existing executory contracts, even after the RTM is completed.
The stock acquisition cases do not establish, however, that the term “by operation
of law” must be construed as Roche contends as a matter of law. First, stock
acquisitions, though similar in some respects, are not RTMs, the transaction structure at
issue here. Hence, stock acquisition cases are not controlling.79 But, they do exemplify a
situation in which a mere change of ownership, without more, does not constitute an
assignment as a matter of law. Yet, here, unlike in Baxter,80 for example, Plaintiffs have
alleged more than a mere change in BioVeris’s ownership status as a result of the
BioVeris Merger. They allege that within months of that transaction, Roche laid off all
triangular merger. The subsidiary usually has no assets other than the merger consideration to be paid to the target. The effect of this arrangement is that the parent does not become a constituent to the merger between the target and the subsidiary.”).
79 Cf. Baxter Pharm. Prods., Inc., 1999 WL 160148, at *5 n.19 (noting that the “significant differences between” stock acquisitions and mergers “render the merger cases inapposite here.”).
80 In Baxter, the court noted that “[e]xcept for the name change, BPP [the subject of the stock acquisition f/k/a OPP] is essentially the same company as the former OPP. BPP sells and markets the same product line, it maintains the same corporate policies, and it employs a large majority of the same sales force and administrative personnel as did OPP. BPP also continues to operate the same facility in New Jersey.” Baxter Pharm. Prods., 1999 WL 160148, at *5.
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of BioVeris’s 200 employees, vacated BioVeris’s Maryland facility, and notified
BioVeris’s existing customers that its product lines were being discontinued.81
While Roche’s construction of “by operation of law” is reasonable, it has cited no
Delaware case that holds that an RTM in circumstances comparable to this case cannot
constitute an assignment by operation of law. In addition, Plaintiffs have alleged specific
facts in support of their allegation that more than a mere change of ownership occurred
with regard to BioVeris as a result of the Merger. Thus, while I find Roche’s
construction reasonable, it is not necessarily the only reasonable interpretation.
For their part, Plaintiffs construe an assignment “by operation of law” as including
mergers, regardless of their kind. For support, they rely on two principal sources: (1)
Delaware cases suggesting that, in the context of FTMs, a merger would constitute an
assignment by operation of law;82 and (2) a California federal court’s holding that an
RTM results in an assignment by operation of law.83
As to the FTM cases, Plaintiffs rely on Tenneco Auto Inc. for the proposition that,
“[a]s a general matter in the corporate context, the phrase ‘assignment by operation of
81 Compl. ¶ 57. Plaintiffs allege that these actions converted BioVeris into a mere holding company for its intellectual property assets. Id.
82 PAB 23-25 (citing, among other cases, Tenneco Auto Inc. v. El Paso Corp., 2002 WL 453930, at *2 (Del. Ch. Mar. 20, 2002), and Star Cellular Tel. Co., v. Baton Rouge CGSA, Inc., 19 Del .J. Corp. L. 875 (Del. Ch. 1993), aff’d, 647 A.2d 382 (Del. 1994)).
83 PAB 28-29 (citing SQL Sol’ns Inc. v. Oracle Corp., 1991 WL 626458 (N.D. Cal. Dec. 18, 1991)).
33
law’ would be commonly understood to include a merger.”84 In that case, NNS I and El
Paso entered into an insurance agreement with an anti-assignment clause similar to § 5.08
here.85 Then, in an FTM, NNS I merged into NNS II, a wholly-owned subsidiary of
Northrup. El Paso claimed that this FTM violated the anti-assignment clause with regard
to rights NNS I had under the insurance agreement. Vice Chancellor Noble explained
that, in isolation, he would read the phrase “by operation of law” in § 8.6 of the insurance
agreement “to preclude a transfer of rights under the Insurance Agreement by merger
absent prior consent from the other parties . . . .”86 He also noted that “the Delaware
Supreme Court has equated an assignment ‘by operation of law’ with a merger” and that
“this Court has suggested that the phrase ‘transfer by operation of law’ would, again in
the corporate context, be understood to include a merger.”87
The Court found that term ambiguous because of its relationship to other language
in § 8.6 and looked to the analysis in Star Cellular for guidance. There, this Court
observed that:
where an antitransfer clause in a contract does not explicitly prohibit a transfer of property rights to a new entity by a
84 Tenneco Auto. Inc., 2002 WL 453930, at *2.
85 The relevant provision in Tenneco states in pertinent part: “8.6 Successors and Assigns. Except as otherwise expressly provided herein, no party hereto may assign or delegate, whether by operation of law or otherwise, any of such party's rights or obligations under or in connection with this Agreement without the written consent of each other party hereto.” Id. at *1.
86 Id. at *2
87 Id. (internal citations omitted).
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merger, and where performance by the original contracting party is not a material condition and the transfer itself creates no unreasonable risks for the other contracting parties, the court should not presume that the parties intended to prohibit the merger.88
The Court in Tenneco determined that because ongoing interactions between the
contracting parties were limited and El Paso faced few adverse consequences as a result
of the FTM, the challenged merger was not prohibited by the nonassignment clause.89
Tenneco and Star Cellular, another case cited by Plaintiffs that arose in the FTM
context, are instructive here because they considered whether an FTM triggers a
nonassignment clause. Nevertheless, as with the cases involving stock acquisitions, they
are not controlling because they did not address whether an RTM also would trigger such
a provision.90
Plaintiffs have cited one case, however, in which a California federal court found
that an RTM did constitute an assignment by operation of law in violation of a governing
contract’s nonassignment clause.91 In SQL Solutions, Inc., the federal district court for
88 Id. at *3.
89 Tenneco Auto. Inc. v. El Paso Corp., 2002 WL 453930, at *4 (Del. Ch. Mar. 20, 2002).
90 In that regard, some commentators have observed that “[w]hile forward subsidiary mergers are commonly viewed as violative of anti-assignment provisions in the disappearing company's contracts, the same conclusion does not necessarily follow with respect to reverse subsidiary mergers.” See Elaine D. Ziff, supra note 78, at 187.
91 SQL Sol’ns, Inc. v. Oracle Corp., 1991 WL 626458, at *3 (N.D. Cal. Dec. 18, 1991). In SQL Solutions, Oracle and D&N executed a software licensing agreement. Thereafter, SybaseSub, a wholly-owned subsidiary of Sybase Inc.
35
the Northern District of California explained that “California courts have consistently
recognized that an assignment or transfer of rights does occur through a change in the
legal form of ownership of a business.”92 The court held that, under California law, a
transfer of the target’s rights under the software agreement in question occurred when the
merger sub merged into the target in an RTM to form a wholly-owned subsidiary of the
acquiring company.93 This case deserves only limited weight, however, for several
reasons. First, as a decision from another jurisdiction, it is not binding on this Court.
Second, the status of the SQL Solutions opinion as an unreported federal district court
case renders it nonbinding in California courts, as well, the state whose law was relevant
to the court’s analysis.94 And, in any event, the court’s reasoning is open to question.
Nevertheless, at this preliminary stage, I am not convinced that Plaintiffs’
construction of § 5.08 as requiring their consent in the circumstances of this case is
unreasonable. First, I know of no Delaware case directly addressing whether an RTM
merged into D&N in an RTM. Id. at *1 (D&N was renamed SQL Solutions after the RTM.) SQL filed a suit for declaratory relief, among other things, when Oracle threatened to terminate the software agreement because D&N allegedly breached the nonassignment clause in that agreement when it transferred its rights thereunder to SQL Solutions. Id.
92 Id. at *3-4 (noting that a transfer of rights is no less a transfer because it occurs by operation of law in a merger).
93 Id. at *4.
94 See Former S’holders v. Browning-Ferris Indus., 2005 WL 2820594, at *5 (Cal. Ct. App. Oct. 28, 2005) (“Plaintiffs rely most heavily on SQL Solutions . . . an unreported federal district court opinion. Obviously SQL Solutions has no precedential value.”).
36
violates a contractual provision preventing the unauthorized assignment “by operation of
law” of an asset held by the target. Delaware, like many of its sister states, apparently
has not yet confronted this issue.95 Second, as discussed supra, to the extent Roche relies
on various stock acquisition cases for the proposition that an RTM does not trigger an
assignment of the rights held by the entity whose stock is acquired because all that has
happened is a mere change of legal ownership, the facts of this case arguably are
distinguishable. Here, Plaintiffs aver that BioVeris not only experienced a change in its
ownership, but also essentially was gutted and converted into a shell company for
Roche’s benefit. Thus, if BioVeris entered an RTM which resulted in more than a mere
change in control, as alleged, there could be an issue of fact as to whether the parties
intended to require Plaintiffs’ consent in this situation by using the term “by operation of
law or otherwise” in § 5.08. Additionally, Plaintiffs plausibly argue that “by operation of
law” was intended to cover mergers that effectively operated like an assignment, even if
95 See, e.g., Shannon D. Kung, Note, The Reverse Triangular Merger Loophole and Enforcing Anti-Assignment Clauses, 103 NW. U. L. REV. 1037, 1053 (2009) (“Delaware courts have not addressed the applicability of anti-assignment clauses in the context of reverse triangular mergers.”); Joshua G. Graubart, Note, Unintended Consequences: State Merger Statutes and Nonassignable Licenses, 2003 DUKE L. & TECH. REV. 25, at *1 (2003) (noting that inconsistency among the states has fostered continuing confusion regarding the efficacy of anti-assignment clauses when confronted with the merger of parties); Kingsley L. Taft, et al., Introduction to Patents and M&A, 931 PLI/PAT 211, 222-23 (2008) (“A reverse triangular merger is generally thought to present the best argument that no assignment has occurred as part of the merger, because the party to the license agreement has not changed. However, there is countervailing case law, notably SQL Solutions . . . .”) (internal citation omitted).
37
it might not apply to mergers merely involving changes of control.96 Therefore, because
the parties offer two competing, but reasonable, constructions of the term “by operation
of law,” I also find that term of the Global Consent to be ambiguous.
c. Harm to Plaintiffs
Finally, while the parties disputed whether the FTM cases, including Star Cellular
and Tenneco, support Plaintiffs’ construction of “by operation of law,” they agreed at the
Argument that, under those cases, if the Court finds the nonassignment clause ambiguous
as to whether it applies to a merger, the Court should consider whether the nonmerging
party suffered harm as a result of the transaction in analyzing whether consent to a
merger was required.97 In Tenneco, after finding the nonassignment provision
ambiguous, Vice Chancellor Noble looked to the presumption articulated in Star
Cellular, which states that:
96 In reaching this conclusion, I am cognizant of the well-settled law of independent legal significance and the respect for separate corporate entities traditionally afforded by Delaware law. These principles may prove important in the ultimate resolution of this dispute. At this early stage of the litigation, however, where the factual record has not been developed, the Court lacks sufficient evidence to choose between two reasonable constructions of a contract.
97 Tr. 33 (Roche: “what Star Cellular and Tenneco really mean is when the meaning of the assignment language is unclear, it is ambiguous, you then can look -- the Court can then look to see if there was any harm.”), 58 (Plaintiffs: “The cases also say, Tenneco and Star Cellular, if you are ambiguous and don't use the "by operation" and want to make it clear, you undertake a harms analysis.”); PAB 29 (“Any ambiguity as to the applicability of the Global Consent’s prohibition of assignments cannot be resolved on a motion to dismiss. This Court has, in construing non-assignment clauses in such circumstances, required inquiry into whether the substance of the transaction harmed the non-consenting party.”).
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Where an antitransfer clause in a contract does not explicitly prohibit a transfer of property rights to a new entity by a merger, and where performance by the original contracting party is not a material condition and the transfer itself creates no unreasonable risks for the other contracting parties, the court should not presume that the parties intended to prohibit the merger.98
The potential relevance of any adverse consequences of the BioVeris Merger to
Plaintiffs provides a further reason to deny Defendants’ motion to dismiss. Neither Star
Cellular nor Tenneco were decided at the motion to dismiss stage. Indeed, the Star
Cellular court looked first to extrinsic evidence concerning the parties’ intent in using the
term “transfer” in a nonassignment provision, which it found unhelpful, before invoking
the presumption outlined above.99 Procedurally, this action is at a much earlier stage.
I note, however, that Plaintiffs’ Complaint alleges that they will suffer significant
harm as a result of the BioVeris Merger. For example, the parties agreed in § 5.09(a) of
the Global Consent that “irreparable damage would occur in the event that any of the
98 Tenneco Auto. Inc. v. El Paso Corp., 2002 WL 453930, at *3-4 (Del. Ch. Mar. 20, 2002) (noting that the Court looks to whether the nonmerging party would suffer “any adverse consequences” as a result of the merger).
99 Star Cellular Telephone Co. v. Baton Rouge Cgsa, Inc., 1993 WL 294847, reprinted in 19 Del. J. Corp. L. 875, 890 (Del. Ch. Aug. 3, 1993) (“To summarize, the inquiry into the “plain meaning” of the Agreement and the extrinsic evidence uncovers nothing which compels the view that the contracting parties intended “transfer” to have the broad meaning that the plaintiffs advocate. Nor, by the same token, does it compel the more restrictive interpretation urged by the defendants. That being the case, the Court, in attempting to ascertain the contracting parties' intent, may consider applicable legal doctrines, including presumptions. . . . That analytical step brings into focus the objectives that parties to an antiassignment clause are generally presumed to be seeking to achieve.”).
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provisions of this Agreement [i.e., § 5.08’s prohibition on unauthorized assignment] were
not performed in accordance with their specific terms or were otherwise breached.”100
This Court has upheld similar contractual stipulations in otherwise enforceable
contracts.101 Plaintiffs also allege that due to Roche acquiring and then dismantling
BioVeris, Plaintiffs lost their bargained-for protection from BioVeris’s independent
watchdog role in preventing encroachment into their “contractually defined and protected
lines of business.”102 The threat of such harm is heightened, according to Plaintiffs, by
Roche’s assertion that the Field limitations in the Roche License ceased to be of any legal
effect once Roche acquired BioVeris.
Thus, the Complaint alleges sufficient facts plausibly to infer that Plaintiffs were
harmed by Roche’s conduct in proceeding with the BioVeris Merger without Plaintiffs’
consent. The possibility of such harm in the context of a dispute over the purported
ambiguity of § 5.08 further indicates that Count I of the Complaint cannot be resolved on
a motion to dismiss.103
100 Global Consent § 5.09(a).
101 See True N. Commc’ns Inc. v. Publicis S.A., 711 A.2d 34, 44 (Del. Ch. 1997) (finding the irreparable harm element of the injunction standard established by a contractual stipulation).
102 See Compl. ¶¶ 61-63; Global Consent § 2.5.
103 In the alternative, Defendants also seek a partial dismissal of Count I to the extent that it seeks to rescind the BioVeris Merger. In particular, they argue that it would be impractical as a matter of law to unwind a consummated merger involving publicly traded corporations whose shares were held by numerous stockholders, and that such relief also is barred by laches, given that several years have passed
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3. Count II: Breach of the Roche License104
Roche argues that Plaintiffs failed to state a claim as to Count II, which accuses
Roche of breaching the Roche License by selling ECL-based products outside of the
Field, for two reasons: (1) as nonparties to that agreement, Plaintiffs lack standing to
enforce it; and (2) even if Plaintiffs do have standing, the Field limitations in the
agreement “ceased to be of any effect once Roche acquired BioVeris.”105 Plaintiffs
dispute Roche’s characterization of the Complaint but argue, as a threshold matter, that
Count II must be submitted to arbitration pursuant to §§ 6.2 and 6.3 of the Roche
License. In this regard, Plaintiffs initiated an arbitration in New York on the same day
since the Merger was consummated. DOB 31-33; DRB 20 (arguing that Delaware courts can dismiss particular requests for relief, even if the plaintiff has stated a claim for relief of some other kind). Although the possibility of rescission-based relief appears remote in the circumstances of this case for some of the reasons stated by Defendants, I consider it premature to rule it out at this early juncture. See Chaffin v. GNI Group, Inc., 1999 WL 721569, at *7 (Del. Ch. Sept. 3, 1999) (“On a motion to dismiss all that need be decided is whether a claim is stated upon which any relief could be granted. If that question is answered in the affirmative, the nature of that relief is not relevant and need not be addressed. In this case the defendants do not challenge the legal sufficiency of the duty of care claims, only the availability of one specific remedy. At this stage, to decide whether rescission relief is (or is not) feasible would not only go beyond the scope of a motion to dismiss, but also would be imprudent, because the issue is fact driven and cannot be decided in the absence of an evidentiary record.”). The decision about what relief, if any, Plaintiffs may be entitled to, therefore, should be made in the context of a more fully developed record.
104 New York law governs the construction of the Roche License. Roche License Agreement § 6.4.
105 Roche also argues that Count II is dependent upon Count I in the sense that a dismissal of Count I would require dismissal of Count II as well.
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they filed this action in Delaware. Alternatively, Plaintiffs’ Complaint seeks an order
compelling Roche to arbitrate their claim under Count II.106
For many of the same reasons it asserts Plaintiffs failed to state a claim under
Count II, Roche opposes arbitration of that Count. Its primary argument is that the Roche
License’s arbitration provisions apply only to “Parties,” the definition of which does not
include MST or MSD, and, therefore, Plaintiffs do not have standing to request
arbitration as to Count II. Consistent with that argument, on August 27, 2010, Roche
petitioned the New York Supreme Court to stay the arbitration Plaintiff initiated in June
2010.107
Thus, before considering the merits, I must address the threshold issues of whether
Plaintiffs are entitled under the Roche License Agreement to demand that Count II be
arbitrated and whether that issue should be decided by this Court or the arbitrator.108 To
106 Compl. ¶¶ 5, 77(a). Roche appears to urge denial of Plaintiffs’ request to arbitrate Count II because they have not formally moved to compel arbitration in this Court and, instead, demanded arbitration in New York. DRB 21. I reject that argument because Plaintiffs’ Complaint fairly raises their demand for arbitration as to Count II, even if they chose to proceed on a parallel track in New York.
107 See Aff. of Sean M. Brennecke (“Brennecke Aff.”) Ex. E. On December 17, 2010, the New York court denied Roche’s motion to stay Plaintiffs’ demand for arbitration in New York. See Docket Item (“D.I.”) 20. Roche appealed this decision on February 10, 2011, and the matter still is pending. D.I. 26.
108 In this regard, I note that, under the Roche License, the issue of arbitrability is governed by federal law. See Roche License Agreement § 6.2(a) (“The Parties intend Section 6.2 hereof to be enforceable in accordance with the Federal Arbitration Act . . . .”). As noted by our Supreme Court, however, “Delaware arbitration law mirrors federal law.” James & Jackson, LLC v. Willie Gary, LLC, 906 A.2d 76, 79 (Del. 2006).
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resolve the latter question, I first must decide whether these issues relate to procedural or
substantive arbitrability.109
a. Do the issues presented involve procedural or substantive arbitrability?
Questions of procedural arbitrability concern whether the parties to a contract
containing a provision mandating arbitration of disputes have complied with the terms of
that provision, including whether “prerequisites such as time limits, notice, laches,
estoppel, and other conditions precedent to an obligation to arbitrate have been met.”110
In general, courts presume that issues relating to procedural arbitrability will be decided
by an arbitrator.111 On the other hand, questions of substantive arbitrability concern
“gateway questions” relating to the applicability of an arbitration provision to a given
dispute.112 Substantive issues require the court to analyze the validity and scope of the
109 See Bell Atl.-Pa., Inc. v. Commc’ns Workers of Am., 164 F.3d 197, 200-01 (3d Cir. 1999) (“Disputes surrounding arbitration have often been divided into the categories of ‘substantive arbitrability’ and ‘procedural arbitrability.’”); Willie Gary, LLC, 906 A.2d at 79; Julian v. Julian, 2009 WL 2937121, at *4-5 (Del. Ch. Sept. 9, 2009) (“In determining whether a claim should be decided before an arbitrator, Delaware courts divide the issue into questions of ‘procedural arbitrability’ and ‘substantive arbitrability.’”).
110 See, e.g., Kristian v. Comcast Corp., 446 F.3d 25, 39 (1st Cir. 2006); United Steel Workers of Am. v. Saint Gobain Ceramics & Plastics, Inc., 505 F.3d 417, 420 (6th Cir. 2007); see also Avnet, Inc. v. H.I.G. Source, Inc., 2010 WL 3787581, at *4 (Del. Ch. Sept. 29, 2010).
111 See, e.g., Kristian, 446 F.3d at 39; Int'l Ass'n of Machinists & Aerospace Workers v. Indresco, Inc.-Indus. Tool Div., 892 F. Supp. 917, 922 (S.D. Tex. 1995).
112 Kristian, 446 F.3d at 39 (identifying “two categories of disputes where we presume that courts rather than arbitrators should resolve the gateway dispute: (1) disputes ‘about whether the parties are bound by a given arbitration clause’; and (2) disagreements ‘about whether an arbitration clause in a concededly
43
arbitration provision.113 When examining substantive arbitrability, the underlying
question is whether the parties decided in the contract to submit a particular dispute to
arbitration.114
Here, the arbitration-related issue before the Court is clearly substantive.
Plaintiffs contend that they are entitled to an order from this Court requiring the parties to
arbitrate Count II. Roche counters that Plaintiffs are not “Parties” to the Roche License
and, therefore, have no right under §§ 6.2 and 6.3 to invoke its arbitration provisions.
Roche draws a distinction between entering into an agreement and merely consenting to
it, which it claims is all Plaintiffs did with regard to the Roche License. According to
Roche, a mere consent entitles Plaintiffs to fewer rights in the contract.115 This dispute
focuses on the gateway issue of whether Plaintiffs may invoke the arbitration provisions
binding contract applies to a particular type of controversy.’”) (internal citations omitted); Bell Atl.-Pa., Inc., 164 F.3d at 200-01; see also Julian, 2009 WL 2937121, at *4.
113 See Bell Atl.-Pa., Inc., 164 F.3d at 200-01 (“Substantive arbitrability refers to the question whether a particular dispute is subject to the parties' contractual arbitration provision(s).”); see also RBC Capital Mkts. Corp. v. Thomas Weisel P’rs, LLC, 2010 WL 681669, at *8 (Del. Ch. Feb. 25, 2010).
114 See Avnet, Inc., 2010 WL 3787581, at *4.
115 For example, Roche contends that “[MSD] consented to the entire [Roche License], but it joined only in the licenses,” and not in other provisions such as the arbitration section. DRB 25 (emphasis in original). For their part, Plaintiffs assert that “four reasons compel arbitration in this case independent of ‘party’ status,” including that the parties to the Roche License Agreement agreed to submit claims such as Count II to arbitration, the broad language of § 6.2 requires arbitration regardless of “party” status, Roche is equitably estopped from opposing arbitration, and if the arbitration clause is ambiguous, all doubts should be resolved in favor of arbitrability. PAB 35-38.
44
in the Roche License based on their having consented to and joined in parts of that
License. I find that issue to be related to the scope of the arbitration provisions and,
therefore, substantive in nature.
b. Should the Court or the arbitrator determine arbitrability?
Unlike issues pertaining to procedural arbitrability, issues of substantive
arbitrability presumptively are to be decided by a court, absent evidence that the parties
“clearly and unmistakably” intended otherwise.116 Roche contends there is “no language
in Section 6 of the [Roche License] permitting [Plaintiffs] to invoke arbitration [so
Plaintiffs’] claim that [they have] a contract-based right to arbitrate must be resolved in
court, not in arbitration.”117 But, before reaching the issue of whether Count II should be
arbitrated, I first must address who should decide that issue: the Court or the arbitrator.118
116 See, e.g., Int'l Ass'n of Machinists & Aerospace Workers v. AK Steel Corp., 615 F.3d 706, 712 (6th Cir. 2010); Contec Corp. v. Remote Sol’n, Co., 398 F.3d 205, 208 (2d Cir. 2005) (“Under the FAA, there is a general presumption that the issue of arbitrability should be resolved by the courts. . . . Acknowledging this presumption, we have held that the issue of arbitrability may only be referred to the arbitrator if there is clear and unmistakable evidence from the arbitration agreement, as construed by the relevant state law, that the parties intended that the question of arbitrability shall be decided by the arbitrator.’”) (emphasis in original) (internal citations omitted); Bell Atl.-Pa., Inc., 164 F.3d at 200-01 (“Absent a clear expression to the contrary in the parties’ contract, substantive arbitrability determinations are to be made by a court and not an arbitrator.”); see also Avnet, Inc., 2010 WL 3787581, at *4 (citing Willie Gary, 906 A.2d at 79); Julian, 2009 WL 2937121, at *4-5 .
117 DRB 23.
118 See Anderson v. Pitney Bowes, Inc., 2005 WL 1048700, at *3-4 (N.D. Cal. May 4, 2005); see also Carder v. Carl M. Freeman Cmtys., LLC, 2009 WL 106510, at *3 (Del. Ch. Jan. 5, 2009).
45
If the answer is the arbitrator, then this Court lacks jurisdiction to decide whether the
particular claims asserted in Count II are subject to arbitration or whether Plaintiffs have
standing under the Roche License to arbitrate them.119
“The issue of who should decide arbitrability turns on what the parties agreed to in
their contract.”120 Because courts presume that the parties did not agree to submit
substantive arbitrability issues to the arbitrator, if the contract is silent or ambiguous, the
court will decide arbitrability.121 But, “if the parties ‘clearly and unmistakably’
empowered an arbitrator to determine arbitrability, the Court must compel arbitration of
the gateway issues as well.”122
The majority federal view, as recognized by the Delaware Supreme Court in Willie
Gary, involves a two-pronged method for determining whether an arbitration clause
constitutes “clear and unmistakable evidence” of the parties’ intent to arbitrate
arbitrability.123 This evidentiary standard is satisfied if an arbitration clause (1) generally
119 See Mehiel v. Solo Cup Co., 2005 WL 1252348, at *7 n.56 (Del. Ch. May 13, 2005) (noting arbitration provides an adequate remedy at law).
120 Anderson, 2005 WL 1048700, at *2; see also First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938, 944 (1995) (“When deciding whether the parties agreed to arbitrate a certain matter (including arbitrability), courts generally [with certain qualifications] . . . should apply ordinary state-law principles that govern the formation of contracts.”).
121 See Anderson, 2005 WL 1048700, at *2.
122 See, e.g., id.; Bell Atl.-Pa., Inc., 164 F.3d at 200-01; see also Willie Gary, LLC, 906 A.2d at 78-79.
123 Willie Gary, 906 A.2d at 80; cf. Contec Corp., 398 F.3d at 208.
46
refers all disputes to arbitration and (2) references a set of arbitral rules, such as the
American Arbitration Association (“AAA”) rules, that empowers arbitrators to decide
arbitrability. 124
I find that, under the standard articulated in federal and Delaware law, the Roche
License arbitration clause contains clear and unmistakable evidence that the parties’
intended to arbitrate arbitrability. First, §§ 6.2 and 6.3 broadly refer all disputes between
the parties to arbitration. In particular, § 6.2(b) states that “[a]ny dispute or other matter
in question between [IGEN and IGEN LS] arising out of or relating to the formation,
interpretation, performance, or breach of this Agreement . . . shall be resolved solely by
arbitration if the Parties are unable to resolve the dispute through negotiation pursuant to
§ 6.1 hereof.”125 Section 6.3 provides that Article 6 of the License, which contains the
arbitration provisions, “shall be the exclusive dispute resolution procedure for Disputes
under this Agreement and no Party shall bring Disputes before any court, except as
124 Willie Gary, 906 A.2d at 80 (“As a matter of policy, we adopt the majority federal view that reference to the AAA rules evidences a clear and unmistakable intent to submit arbitrability issues to an arbitrator. We do so in the belief that Delaware benefits from adopting a widely held interpretation of the applicable rule, as long as that interpretation is not unreasonable. The majority view does not, however, mandate that arbitrators decide arbitrability in all cases where an arbitration clause incorporates the AAA rules. Rather, it applies in those cases where the arbitration clause generally provides for arbitration of all disputes and also incorporates a set of arbitration rules that empower arbitrators to decide arbitrability.”); see also id. at n.9.
125 Roche License Agreement § 6.2(b).
47
appeals to arbitration awards are permitted by Section 6.2.”126 Second, § 6.2(f) refers to
the AAA rules, which permit arbitrators to decide arbitrability.127 Therefore, I find that
the Parties to the Roche License clearly and unmistakably committed questions of
arbitrability to the arbitrator.
This conclusion also withstands Roche’s argument that Plaintiffs lack standing to
compel Roche to arbitrate their claim because they were not “Parties” to the license, and
merely joined in or consented to it. Although it is tempting to address that issue on its
merits, it would be inconsistent with Willie Gary for a court to address the merits of the
underlying claim once it has determined that an arbitrator should decide arbitrability.128
Nevertheless, consistent with my holdings in Julian, in cases where the parties dispute
whether the arbitrator should decide arbitrability because one party claims the other does
not have standing to compel arbitration, “a court conceivably could consider a
preliminary question of whether or not there is a colorable basis for the court to conclude
that” the opposing party, in fact, has such standing.129 As such, “[i]f there is such a
126 Id. § 6.3.
127 Id. § 6.2(f) (“Except as provided above, arbitration shall be based upon the Commercial Arbitration Rules of the American Arbitration Association. . . .”). Rule 7 of the AAA Rules provides, with respect to jurisdiction, that “[t]he arbitrator shall have the power to rule on his or her own jurisdiction, including any objections with respect to the existence, scope or validity of the arbitration agreement.” AAA Commercial Arbitration Rule R-7(a), available athttp://www.adr.org/sp.asp?id=22440#R7.
128 See generally Julian v. Julian, 2009 WL 2937121, at *7 (Del. Ch. Sept. 9, 2009); McLaughlin v. McCann, 942 A.2d 616, 627 (Del. Ch. 2008).
129 Julian, 2009 WL 2937121, at *7.
48
colorable basis, along with a broad clause and reference to the AAA Rules or something
analogous to them, then the question of substantive arbitrability should be sent to the
arbitrator.”130
Plaintiffs MST and MSD have stated a colorable basis for their claim of standing
to compel Roche to arbitrate Count II. In Contec Corp. v. Remote Solution, Co., for
example, the Second Circuit faced the similar issue of “whether a non-signatory can
compel a signatory to arbitrate under an agreement where the question of arbitrability is
itself subject to arbitration.”131 The plaintiff, Remote Solution, argued it could not be
compelled to arbitrate with the defendant, Contec, because the defendant was a “stranger”
to the 1999 agreement to which the plaintiff was a signatory and which contained the
relevant arbitration provision.132 The court explained that:
just because a signatory has agreed to arbitrate issues of arbitrability with another party does not mean that it must arbitrate with any non-signatory. In order to decide whether arbitration of arbitrability is appropriate, a court must first determine whether the parties have a sufficient relationship to each other and to the rights created under the agreement. . . . A useful benchmark for relational sufficiency can be found in our estoppel decision in Choctaw Generation Ltd. P'ship v. Am. Home Assurance Co., where we held that the signatory to an arbitration agreement “is estopped from avoiding arbitration with a non-signatory ‘when the issues the non-signatory is seeking to resolve in arbitration are intertwined
130 Id.
131 398 F.3d 205, 209 (2d Cir. 2005).
132 Contec L.P., the other signatory, had merged with the defendant, leaving the latter as the surviving entity.
49
with the agreement that the estopped party has signed.’” . . . In Choctaw, we summarized the factors laid out in Smith/Enron as “the relationship among the parties, the contracts they signed (or did not), and the issues that ha[ve] arisen.”133
Applying these factors, the court found a sufficient relationship between the plaintiff and
the non-signatory defendant based on: the relationship between each Contec entity and
the plaintiff; the fact that the plaintiff had signed the agreement; and the existence of a
dispute between the parties that related to the 1999 agreement regardless of the change in
the defendant’s corporate form.134 Having found such a relationship between the parties,
the court held that because the plaintiff “‘agreed to be bound’ by provisions that ‘clearly
and unmistakably allow the arbitrator to determine her own jurisdiction’ over an
agreement to arbitrate ‘whose continued existence and validity is being questioned,’ it is
the province of the arbitrator to ‘decide whether a valid arbitration agreement exists.’”135
As in the Contec case, I find that Plaintiffs have at least a colorable basis for
standing here. Roche agreed to be bound by § 6.2 of the Roche License, which, as
explained above, clearly and unmistakably permits the arbitrator to determine
arbitrability regarding an agreement whose scope is being questioned by Plaintiffs.
Moreover, Plaintiffs actually signed the Roche License signifying that they consented to
it and “joined in” parts of it, at least. Thus, in accordance with federal precedent, I hold
133 Id. at 209 (citations omitted).
134 See id.
135 Id. at 211.
50
that whether Plaintiffs have standing to demand arbitration of their claims under Count II
also is for the arbitrator to decide.
Accordingly, I deny Roche’s motion to dismiss Count II and stay further
proceedings on that Count pending the arbitrator’s decision on the arbitrability of that
Count or until further order of this Court.136
4. Dismissal of nonparties to the Global Consent and Roche License?
Finally, Roche argues that, even if Plaintiffs have stated a claim as to Count II, I
should dismiss Roche Diagnostics GmbH, Roche Diagnostics Corporation, and LAC
because those entities are not, nor have they ever been, parties to the Global Consent or
Roche License and, thus, cannot be held liable for any breach that might have occurred.
In resisting dismissal of those entities, Plaintiffs argue that, based on the allegations in the
Complaint, one or more of those entities may be necessary or appropriate.
136 Roche argues, in the alternative, that the Court should dismiss Count II because Plaintiffs breached their covenant not to sue found in the Meso Consent to the Roche License. In the Consent, MSD and MST represented and warranted to Roche that “each of them hereby waives any right that either of them may have to in any way restrict or limit [Roche]’s exercise of the licenses granted in the [Roche License] during the Term thereof.” Roche License Agreement at Meso Consent. Roche asserts that Plaintiffs breached this covenant by interfering with its rights under the Roche License by “seeking to reform that agreement to make [MSD] a party and claim BioVeris’ 65% royalty for itself” in Count II of this action. DRB 29. All of these issues, however, “aris[e] out of or relat[e] to the formation, interpretation, performance, or breach of [the Roche License].” Roche License Agreement § 6.2(b). Therefore, they must be presented to the arbitrator, not the Court.
51
I agree with Plaintiffs. Generally, a plaintiff may sue for breach of contract only
those entities who are parties to the disputed contract.137 Under Rule 20(a), however, a
plaintiff may join “[a]ll persons . . . in 1 action as defendants if there is asserted against
them jointly, severally, or in the alternative, any right to relief in respect of or arising out
of the same transaction, occurrence or series of transactions or occurrences and if any
question of law or fact common to all defendants will arise in the action.”138
Here, Plaintiffs have sought relief against all named defendants based on alleged
misconduct arising out of the same transactions: the Transaction and the BioVeris
Merger. The three entities who seek dismissal are affiliates of Roche and had an interest
or role in those transactions. Moreover, common questions of law and fact abound with
regard to whether those entities also may be subject to injunction or other relief that
might be granted to Plaintiffs in this action. For example, the Complaint raises a
plausible claim that “Roche Diagnostics” asserted an interest in using and expanding its
137 Wallace v. Wood, 752 A.2d 1175, 1180 (Del. Ch. 1999); accord Pac. Carlton Dev. Corp. v. 752 Pacific, LLC, 878 N.Y.S.2d 421, 422 (N.Y. App. Div. 2009) (noting that, in general, a person who is not party to a contract may not be bound by it); A & V 425 LLC Contracting Co. v. RFD 55th Street LLC, 830 N.Y.S.2d 637, 643 (N.Y. Sup. 2007) (“As a general rule, in order for someone to be liable for a breach of contract, that person must be a party to the contract.”).
138 Ct. Ch. R. 20(a) (“A plaintiff or defendant need not be interested in obtaining or defending against all the relief demanded. Judgment may be given for 1 or more of the plaintiffs according to their respective rights to relief, and against 1 or more defendants according to their respective liabilities.”)
52
ECL business beyond the parameters of the Field restrictions.139 In addition, LAC was
the subsidiary through which Roche acquired BioVeris’s intellectual property rights. At
this early stage in the proceedings, I cannot rule out the possibility that certain equitable
relief granted by this Court would include relief against LAC.
Therefore, Plaintiffs have asserted a sufficient basis under Rule 20(a) to join
Roche Diagnostics GmbH, Roche Diagnostics Corporation, and LAC as Defendants
here.140 Accordingly, I deny Defendants’ motion to dismiss the Complaint as to those
Defendants.
139 See Compl. ¶ 53 (citing a press release in which Roche declared that Roche Diagnostics could expand its immunochemistry business beyond the Field restrictions). This allegation does not differentiate between Roche Diagnostics “GmbH” and “Corporation.” Nevertheless, the Complaint has fairly alleged a claim against both of these entities, as affiliates of Roche, sufficient to satisfy the requirements of permissive joinder.
140 Indeed, the same reasons arguably support joining the three disputed entities as necessary parties under Rule 19(a). That rule states that a person or entity should be joined as a party to an action if “(1) in the person's absence complete relief cannot be accorded among those already parties, or (2) the person claims an interest relating to the subject of the action and is so situated that the disposition of the action in the person's absence may (i) as a practical matter impair or impede the person's ability to protect that interest or (ii) leave any of the persons already parties subject to a substantial risk of incurring double, multiple, or otherwise inconsistent obligations by reason of the claimed interest.” Ct. Ch. R. 19(a). Here, Plaintiffs appear to meet the first prong of Rule 19(a). If Roche Diagnostics GmbH continues to sell Products out of Field in violation of the Roche License, for example, an injunction directed solely against the primary Roche entities might not constitute complete relief.
53
III. CONCLUSION
For the reasons stated, I deny Roche’s motion to dismiss Counts I and II of the
Complaint. In addition, I stay any further proceedings as to Count II pending the
resolution of the arbitrator’s decision on the arbitrability of that Count or further order of
this Court.
IT IS SO ORDERED.
Of the Federal Circuit, sitting by designation.*
United States Court of AppealsFor the First Circuit
No. 09-1089
SONORAN SCANNERS, INC.;JOSEPH P. DONAHUE,
Plaintiffs, Appellants,
v.
PERKINELMER, INC.,
Defendant, Appellee.
APPEAL FROM THE UNITED STATES DISTRICT COURTFOR THE DISTRICT OF MASSACHUSETTS
[Hon. William G. Young, U.S. District Judge]
Before
Torruella, Boudin, and Dyk,*
Circuit Judges.
Edward T. Dangel, III, with whom Dangel & Mattchen, LLP,was on the brief, for appellants.
Jonathan Isaac Handler, with whom Jillian B. Hirsch andDay Pitney, LLP, was on the brief, for appellee.
October 29, 2009
Case: 09-1089 Document: 00115968629 Page: 1 Date Filed: 10/29/2009 Entry ID: 5389026
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DYK, Circuit Judge. Plaintiffs Joseph P. Donahue
(“Donahue”) and Sonoran Scanners, Inc. (“Sonoran”) appeal from an
order of the United States District Court for the District of
Massachusetts granting summary judgment to defendant PerkinElmer,
Inc. (“PerkinElmer”) on claims for breach of contract and violation
of Massachusetts General Laws Chapter 93A, Mass. Gen. Laws ch. 93A
§ 11. These claims arise from an Asset Purchase Agreement
(“Purchase Agreement”) in which PerkinElmer acquired Sonoran’s
computer-to-plate printing technology business (“CTP Business”) and
an employment agreement (“Employment Agreement”) under which
Donahue (the founder of Sonoran) agreed to serve as “Site Leader
and General Manager” of the CTP Business for PerkinElmer. Sonoran
Scanners, Inc. v. PerkinElmer, Inc., 590 F. Supp. 2d 196 (D. Mass.
2008).
We agree that the district court correctly granted
summary judgment to PerkinElmer with respect to most of the claims.
However, we conclude that under Massachusetts law the Purchase
Agreement contains an implied contractual term that required
PerkinElmer to use reasonable efforts to develop and promote
Sonoran’s technology. Accordingly, in this one respect, we reverse
the district court’s grant of summary judgment and remand for
further proceedings. In all other respects, we affirm.
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I.
Because this appeal is from a grant of summary judgment,
we view the record in the light most favorable to the non-moving
parties (here Sonoran and Donahue). Morelli v. Webster, 552 F.3d
12, 15 (1st Cir. 2009).
Sonoran is an Arizona corporation founded in 1997 by
Donahue, an engineer and businessman, to develop and market high-
speed computer-to-plate (“CTP”) technology to the newspaper and
graphic arts industries. The CTP technology developed by Sonoran
was intended to be a high-speed digital printing alternative,
superior to the costly and time-consuming analog process required
by conventional plate technology. Sonoran’s CTP technology
required a greater initial capital investment from customers than
conventional technology (approximately $500,000 per unit), but
potentially offered significant cost savings over the life of the
product. As of 2000, Sonoran had developed a prototype CTP
machine, but had not made any sales. Although there was interest
in Sonoran’s product, some customers expressed concern as to
whether the company was too small to assure long-term support for
the unproven technology. By mid-2000, Sonoran was running out of
cash despite Donahue’s investment of approximately $3.5 million of
his own money in the company. Facing these challenges, Sonoran
sought a purchaser to undertake the continued development and
marketing of its CTP technology.
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PerkinElmer is a publicly-traded Massachusetts
corporation headquartered in Wellesley, Massachusetts. In late
2000, Donahue approached PerkinElmer to determine if PerkinElmer
was interested in purchasing Sonoran’s CTP Business. PerkinElmer
was amenable to Donahue’s overtures, and after negotiations, agreed
to purchase substantially all of Sonoran’s assets and business.
PerkinElmer and Sonoran executed an “Asset Purchase
Agreement” (“Purchase Agreement”) on May 2, 2001. Under § 1.4 of
the Purchase Agreement, at closing PerkinElmer paid $3.5 million.
Some significant portion of that amount went directly to Sonoran’s
unsecured creditors. In addition, §§ 1.6 and 6.2 of the Purchase
Agreement (entitled “Additional Earnout Payments”) provided that
PerkinElmer would pay Sonoran additional amounts if certain CTP
product sales targets were met each year between 2001 and 2006.
Under the terms of the earn-out provisions, PerkinElmer would pay
Sonoran $750,000 if at least three CTP machines were sold in the
first year following closing, $1.5 million (less any previously
paid earn-out amounts) if at least ten machines were sold by the
end of the second year, and additional amounts if certain gross
margin targets on sales of CTP machines were met. The additional
earnout payment (over and above the $1.5 million) during the five
year payout period was a maximum of $2 million.
Also relevant to this dispute are § 6.1 and § 6.3 of the
Purchase Agreement. Section 6.3, entitled “Sharing of Data,”
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provided in part that “The Parties agree that from and after the
Closing Date they shall cooperate fully with each other to
facilitate the transfer of the Acquired Assets from the Seller to
the Buyer and the operation thereof by the Buyer.” Purchase
Agreement § 6.3(b) (emphasis added). Section 6.1 stated that “The
Buyer or a subsidiary of the Buyer shall offer employment to those
Employees identified on Schedule 6.1 attached hereto . . . .”
Schedule 6.1, in turn, listed eight Sonoran employees and stated
whether or not each had accepted an offer of employment from
PerkinElmer. The only employee on Schedule 6.1 who had not
accepted an employment offer before execution of the Purchase
Agreement was Norm Bogen, Sonoran’s chief of sales and marketing
and principal salesman.
PerkinElmer also entered into a separate employment
agreement (“Employment Agreement”) with Donahue, under which
Donahue was to serve as “Site Leader and General Manager” of the
CTP Business for PerkinElmer for a salary of $150,000 per year.
The Employment Agreement also specified that Donahue would be
eligible to receive, for five years, bonuses (limited in the
aggregate to $6.6 million) based on CTP sales and to be calculated
in a manner similar to the earn-out payments potentially payable to
Sonoran. The Annual Bonus Section of the Employment Agreement
stated that Donahue would “have the right to consult with
[PerkinElmer] regarding the pricing of [CTP] Product sales.”
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Upon closing, Sonoran’s CTP Business (which remained
located in Tucson, Arizona) became part of PerkinElmer’s Azusa,
California-based Lithography Systems division (“Lithography”).
It is undisputed that the CTP Business, as operated by
PerkinElmer, was a failure. Between May 2001 and October 2004,
only one CTP unit was sold and no additional amounts were paid
under the provisions of the Purchase Agreement or Employment
Agreement to Sonoran or Donahue. According to Sonoran and Donahue,
the CTP Business’s failure to thrive was the avoidable result of a
series of unreasonable and bad faith decisions by PerkinElmer.
By 2004 PerkinElmer was pursuing an exit strategy for the
CTP Business. In September 2004 PerkinElmer sold its CTP assets to
MacDermid, Inc. In October 2004 PerkinElmer shuttered the CTP
Business and laid off the associated staff, including Donahue.
On November 20, 2006, Sonoran and Donahue sued
PerkinElmer in the United States District Court for the District of
Massachusetts basing jurisdiction on diversity of citizenship.
Insofar as is pertinent to this appeal, Sonoran and Donahue sued to
recover on four separate theories. First, Sonoran alleged that
PerkinElmer breached the express terms of the Purchase Agreement by
failing to “cooperate fully” with Sonoran and by failing to hire
Bogen in accordance with §§ 6.3 and 6.1 respectively of the
Purchase Agreement. Second, Sonoran and Donahue claimed that
PerkinElmer breached the implied covenant of good faith and fair
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In the complaint, Donahue alleged additional theories1
concerning breach of the Employment Agreement that are notpresented in this appeal. We note that Donahue signed the PurchaseAgreement as “Principal Stockholder.” That Agreement, however, wassilent as to any obligations running directly from PerkinElmer toDonahue (though there are some obligations running from Donahue toPerkinElmer). We assume that Donahue’s claims are limited to hisrights under the Employment Agreement.
-7-
dealing in both the Purchase Agreement and the Employment Agreement
by engaging in bad faith conduct. Third, Sonoran claimed that
PerkinElmer breached the implied terms of the Purchase Agreement by
failing to make good faith and reasonably competent and diligent
efforts to develop, market, and sell Sonoran’s CTP products.
Finally, Sonoran contended that PerkinElmer violated Chapter 93A,
Mass. Gen. Laws ch. 93A § 11, by engaging in unfair or deceptive
conduct.1
Following discovery, the district court granted summary
judgment to PerkinElmer on all four claims. The court held that no
express term of the Purchase Agreement had been violated. With
regard to breach of the implied covenant of good faith and fair
dealing in both the Purchase and Employment Agreements, the court
held that “[t]he parallel economic interests of the parties compels
a conclusion that PerkinElmer did not intend to deny Plaintiffs the
fruits of the contract[s]” and thus that no breach could be shown.
Sonoran, 590 F. Supp. 2d at 211. The court added that “[e]ven were
this Court to find that PerkinElmer intended to deny the Plaintiffs
the benefit of the contractual earnouts, on the record before the
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Court, the Plaintiffs would have great difficulty establishing that
PerkinElmer’s conduct caused the injuries the Plaintiffs allege”
and that “they have not presented evidence sufficient to establish
their damages with the necessary certainty.” Id. The court
further found that the Purchase Agreement contained no implied
“obligation to continue operating the CTP Business” in the face of
millions of dollars of losses. Id. at 206. Finally, the court
held that Sonoran’s Chapter 93A claim must fail because the claim
relies exclusively on the same set of operative facts as the
Plaintiffs’ failed common law claims, and thus summary judgment was
appropriate on that claim as well. Id. at 212.
Sonoran and Donahue timely appealed from the judgment of
the district court dated December 23, 2008, and we have
jurisdiction under 28 U.S.C. § 1291.
II.
We review the district court’s grant of summary judgment
de novo, drawing all reasonable inferences in favor of the
nonmoving party. Fenton v. John Hancock Mut. Life Ins. Co., 400
F.3d 83, 87 (1st Cir. 2005).
A. Breach of the Express Terms of the Purchase Agreement
Sonoran first contends that PerkinElmer breached the
express terms of the Purchase Agreement, focusing on §§ 6.1 and
6.3 of the Agreement. The district court held that no reasonable
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-9-
jury could conclude that PerkinElmer breached any express
provision, and we agree.
We begin with Sonoran’s contention that PerkinElmer
breached § 6.3(b) of the Purchase Agreement. That provision,
entitled “Sharing of Data,” provided in part that “The Parties
agree that from and after the Closing Date they shall cooperate
fully with each other to facilitate the transfer of the Acquired
Assets from the Seller to the Buyer and the operation thereof by
the Buyer.” Purchase Agreement § 6.3(b) (emphasis added).
Although Sonoran apparently contends that the “shall cooperate
fully” language of § 6.3(b) created a freestanding obligation on
the part of PerkinElmer to “cooperate” with Sonoran and Donahue in
operating the business, the unambiguous language of the provision
was to the contrary. See, e.g., Eigerman v. Putnam Invs., Inc.,
877 N.E. 2d 1258, 1263 (Mass. 2007) (courts interpret contracts
according to plain terms where these are unambiguous).
Specifically, § 6.3(b) stated that the duty of cooperation was
intended to benefit PerkinElmer——that the parties shall cooperate
to facilitate transfer of Sonoran’s business “to the Buyer” and to
facilitate “the operation thereof by the Buyer.” Purchase
Agreement § 6.3(b) (emphasis added). The district court correctly
held that no basis exists to conclude that PerkinElmer breached
§ 6.3 of the Purchase Agreement.
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Equally unavailing is Sonoran’s argument that PerkinElmer
breached § 6.1 of the Purchase Agreement by failing to hire Bogen.
That provision stated that “The Buyer or a subsidiary of the Buyer
shall offer employment to those Employees identified on Schedule
6.1 attached hereto . . . .” Purchase Agreement § 6.1 (first
emphasis added). Sonoran maintains that the district court erred
by failing “to give any forward-looking meaning” to the phrase
“shall offer employment” such that PerkinElmer was required to make
a better offer to Bogen post-closing.
During negotiations with PerkinElmer before execution of
the Purchase Agreement, Donahue made clear to PerkinElmer that
Bogen would require a raise from his current salary of $100,000 a
year to $125,000 a year, as well as reimbursement for commuting
expenses and a fair commission, in order to remain with the
business. In April 2001 PerkinElmer made offers to the eight
Sonoran employees listed in Schedule 6.1 of the Purchase Agreement,
including Norm Bogen. PerkinElmer offered Bogen only his current
salary with no additional amount for expenses or commission. Bogen
rejected the offer. Upon learning of Bogen’s rejection, Donahue
asked Greg Baxter, the head of Lithography, to increase the offer.
Baxter represented that he would get a better offer for Bogen after
closing, though no such language was added to the Purchase
Agreement. PerkinElmer never made a better offer to Bogen, and
Bogen never accepted employment with PerkinElmer.
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Because the plain language of the provision is2
unambiguous, Sonoran’s argument that certain parole evidence(including pre-closing conversations in which Baxter representedthat Bogen would receive a better offer after closing) creates aquestion of fact is without merit. The Purchase Agreement includesan integration clause. See Bank v. Int’l Bus. Machs. Corp., 145F.3d 420, 424 (1st Cir. 1998) (noting that under Massachusetts law,an integrated contract, “if unambiguous, cannot be modified byevidence of earlier or contemporaneous discussions”).
-11-
We agree with the district court that § 6.1 only required
PerkinElmer to make a bona fide offer of employment to Bogen; it
did not require PerkinElmer to make any particular offer to Bogen
or to make a second, better offer to Bogen after closing when the
first offer was rejected by Bogen. Schedule 6.1 of the Purchase2
Agreement confirmed this interpretation of § 6.1. That schedule
listed eight Sonoran employees, including Bogen, and indicated that
each employee but Bogen had accepted PerkinElmer’s offer of
employment by the May 2, 2000, closing. This clearly indicated
that making an offer of employment before execution of the Purchase
Agreement complied with § 6.1. Under these circumstances, the
failure to make an offer of employment to Bogen after execution of
the Purchase Agreement could not be a violation of the Purchase
Agreement.
In sum, the district court correctly granted summary
judgment that PerkinElmer did not breach any express terms of the
Purchase Agreement.
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Compare, e.g., Birbiglia v. St. Vincent Hosp., Inc., 6923
N.E.2d 9, 14 n.5 (Mass. 1998) (suggesting in a footnote thatspecific intent would be required to establish a violation of anyduty of good faith and fair dealing), and Towner v. BenningtonConst. Co., No. 0033B, 2005 WL 3105653 at *11 n.6 (Mass. Super. Ct.Oct. 12, 2005) (unreported) (reading Birbiglia as stating that a“plaintiff must show ‘specific intent’ to violate duty of goodfaith and fair dealing,” meaning intent “to deprive [plaintiff] ofthe fruits of the contract”), with Philip Alan, Inc. v. Sarcia, No.0500437, 2007 WL 738484 at *10 (Mass. Super. Ct. Feb. 6, 2007)(unreported) (rejecting specific intent standard and stating that“[n]ot only does that lonely footnote [in Birbiglia] fail toclearly state that specific intent must be alleged in order toproceed with a claim of bad faith, this court has not been guidedto any other cases which so hold”).
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B. Breach of the Implied Covenant of Good Faith and FairDealing
Sonoran and Donahue further contend that PerkinElmer
breached the implied covenant of good faith and fair dealing in
both the Purchase Agreement and the Employment Agreement by
engaging in bad faith conduct, including misrepresenting its
intention to give Bogen a better offer and failing to disclose the
Lithography Division’s true financial condition. The district
court rejected this claim on the ground that there was no evidence
that could support a finding that PerkinElmer intended to deprive
Sonoran or Donahue of the fruits of the contracts.
The parties devoted much of their briefing for this claim
to the issue of whether specific intent is a necessary element of
the implied covenant of good faith and fair dealing. Indeed,
Massachusetts law is unclear whether specific intent is required
for this claim. But it is not necessary to resolve the specific3
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We agree that the other alleged instances of bad faith4
were properly rejected by the district court.
-13-
intent dispute. Establishing a violation of the covenant of good
faith and fair dealing requires at least bad faith conduct. See
Schultz v. R.I. Hosp. Trust Nat’l Bank, N.A., 94 F.3d 721, 730 (1st
Cir. 1996); Equip. & Sys. for Indus. v. Northmeadows Constr. Co.,
798 N.E.2d 571, 575 (Mass. App. Ct. 2003); Shawmut Bank, N.A. v.
Wayman, 606 N.E.2d 925, 928 (Mass. App. Ct. 1993); see also FAMM
Steel, Inc. v. Sovereign Bank, 571 F.3d 93, 100 (1st Cir. 2009).
The district court correctly determined that there were
only two potential instances of alleged bad faith on PerkinElmer’s
part. Both instances concerned only the Purchase Agreement and4
not the Employment Agreement——namely, PerkinElmer’s representations
regarding its intention to offer Bogen a better employment contract
and its failure to inform Sonoran and Donahue that its Lithography
Division was struggling financially. However, statements that are
made before a contract is executed are “inadequate” for a claim of
breach of the implied covenant of good faith and fair dealing.
Accusoft Corp. v. Palo, 237 F.3d 31, 45 (1st Cir. 2001) (“It is
implicit in [the definition of the implied covenant of good faith
and fair dealing] that the prohibition contained in the covenant
applies only to conduct during performance of the contract, not to
conduct occurring prior to the contract’s existence, such as
conduct affecting contract negotiations.” (citing FDIC v. LeBlanc,
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-14-
85 F.3d 815, 822 (1st Cir. 1996), and Restatement (Second) of
Contracts § 205, cmt. c)); see also Eigerman v. Putnam Invs., Inc.,
877 N.E.2d 1258, 1265 (Mass. 2007) (stating that the implied
covenant of good faith and fair dealing only “concerns the manner
in which existing contractual duties are performed”); Human Res.
Dev. Press, Inc. v. IKON Office Solutions Co., No. 05-30068-KPN 3,
2006 U.S. Dist. LEXIS 1613 at *26 (D. Mass. Jan. 12, 2006).
While the failure to make a new and better offer to Bogen
occurred after the execution of the Purchase Agreement, the alleged
bad faith conduct here was the representation during negotiations
that a post-execution offer would be made to Bogen. In other
words, the bad faith act occurred before, not after, execution of
the Purchase Agreement. The same is true with respect to the
representations as to the financial condition of the Lithography
Division.
Thus, the district court did not err in granting summary
judgment that PerkinElmer did not breach the implied covenants of
good faith and fair dealing.
C. Breach of the Implied Reasonable Efforts Term of theAgreement
Sonoran next asserts that, under the Purchase Agreement,
PerkinElmer had an implied obligation to exert reasonable efforts
to develop and promote Sonoran’s technology, and that it breached
its obligation. PerkinElmer in turn argues Massachusetts does not
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-15-
recognize such an implied obligation, at least not under the
circumstances involved here. We conclude that PerkinElmer did have
an implied obligation under the Purchase Agreement to use
reasonable efforts, and we reverse and remand for a determination
of whether PerkinElmer breached this obligation with respect to the
Purchase Agreement only.
Justice Cardozo’s opinion in Wood v. Lucy, Lady Duff-
Gordon, 118 N.E. 214 (N.Y. 1917), has influenced courts nationwide,
including Massachusetts courts, to follow the principle that:
We are not to suppose that one party was to beplaced at the mercy of the other. . . . [The]promise to pay the defendant one-half of theprofits and revenues resulting from theexclusive agency and to render accountsmonthly was a promise to use reasonableefforts to bring profits and revenues intoexistence.
Lady Duff, 118 N.E. at 215-16. Citing to Lady Duff, the
Massachusetts Supreme Judicial Court has held that it is implied
that one who obtains the exclusive right to manufacture a product
under a patent has “an implied obligation . . . to exert reasonable
efforts to promote sales of the process and to establish, if
reasonably possible, an extensive use of the invention.” Eno Sys.,
Inc. v. Eno, 41 N.E.2d 17, 19-20 (Mass. 1942).
PerkinElmer contends that implying a reasonable efforts
obligation is only necessary and appropriate where there is no
other consideration supporting the existence of a contract. Thus,
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-16-
PerkinElmer seeks to limit the implied reasonable efforts
obligation to contracts in which there is no consideration other
than reasonable efforts. It points out that it paid $3.5 million
in consideration at closing, and concludes that the reasonable
efforts obligation does not apply here. While some jurisdictions
may have adopted this rule, see Emerson Radio Corp. v. Orion Sales,
Inc., 253 F.3d 159, 169 (3d Cir. 2001); WrestleReunion, LLC v. Live
Nation Television Holdings, Inc., No. 8:07-cv-2093-JDW-MAP, 2009
U.S. Dist. LEXIS 70285, at *26-27 (M.D. Fla. Aug. 11, 2009),
Massachusetts has not. In Eno, for example, Mrs. Eno entered into
an arrangement with a company to market a particular type of tape
useful in the manufacture of shoes. Eno, 41 N.E.2d at 18. Under
the license, Eno Systems was to pay Mrs. Eno $100 per month where
the sales of tape were below 250,000 yards, and $200 per month
where yardage exceeded that amount. Thus, even if Eno Systems had
done nothing to exploit the patent, Mrs. Eno would have been
entitled to $100 per month for the life of the patent. Despite
this consideration, the court implied a reasonable efforts clause
to maximize revenue based on the intent of the parties. Id. at 19.
PerkinElmer also attempts to distinguish Eno as limited
to exclusive licensing arrangements. PerkinElmer asserts that the
implied reasonable efforts duty is inapplicable here because it
“did not obtain an exclusive license but rather purchased Sonoran’s
assets.” The district court found this argument compelling. We do
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See also Bell v. Streetwise Records, Ltd., 761 F.2d 67,5
73, 75 (1st Cir. 1985) (finding that the employment contractsbetween the plaintiffs, the members of a rock group, and thedefendants, a record company and a manager, were “‘instinct’ withthat obligation” and required each party to maximize the sale ofrecords and royalties).
-17-
not because Massachusetts law is to the contrary. The fact that
Eno involved exclusive licensing arrangements does not lessen the
obligation to use reasonable efforts in other situations. See,
e.g., Brightwater Paper Co. v. Monadnock Paper Mills, 161 F.2d
869, 871 (1st Cir. 1947) (holding that the plaintiff had an implied
duty to use reasonable efforts to elicit particular business and to
hand it over to the defendant); Russo v. Enter. Realty Co., 199
N.E.2d 689, 692-93 (Mass. 1964) (imposing a duty on a seller of
land to use reasonable efforts to build a road of the width shown
on its subdivision plan as part of its closing obligations);
Graustein v. HP Hood & Sons, Inc., 200 N.E. 14, 20 (Mass. 1936)
(implying a duty on a purchaser of a retail milk delivery company
to make “reasonably diligent and persistent effort to collect [on
seller’s behalf] all the accounts recorded in the books which it
took over”). Rather, the key under Massachusetts law is that the5
instrument as a whole must make certain that the reasonable efforts
term was implicit. Eno, 41 N.E.2d at 19; see also Spaulding v.
Morse, 76 N.E.2d 137, 139 (Mass. 1947) (“[I]f the instrument as a
whole produces a conviction that a particular result was fixedly
desired although not expressed by formal words, that defect may be
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Indeed Sonoran alleged that all of the $3.5 million was6
paid to Sonoran’s creditors. Pls.’ Counter-Statement of MaterialFacts ¶ 13.
-18-
supplied by implication and the underlying intention . . . may be
effectuated, provided it is sufficiently declared by the entire
instrument.” (citing Dittemore v. Dickey, 144 N.E. 57 (Mass.
1924))).
Here various aspects of the Purchase Agreement in
addition to the contingent nature of Sonoran’s compensation support
its argument that the reasonable efforts term was implicit. The
earnout compensation was substantial (potentially $3.5 million) in
relation to the up-front payments made by PerkinElmer ($3.5
million). A significant portion of the $3.5 million was paid to
Sonoran’s creditors and did not benefit the shareholders directly.6
The Purchase Agreement contemplated a campaign to market the
Sonoran technology over the next five years (although this does not
suggest that it would not be reasonable to abandon those efforts
before the end of the five-year period). There was no language in
the agreement negating an obligation by PerkinElmer to use
reasonable efforts or conferring absolute discretion on PerkinElmer
as to the operation of the business. Under these circumstances, we
find that PerkinElmer had an implied obligation to use reasonable
efforts to develop and promote Sonoran’s technology.
Given that PerkinElmer had an implied obligation to exert
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-19-
reasonable efforts towards promoting sales of the CTP machines, the
factual question remains whether PerkinElmer breached this
obligation. On this question, as might be expected, the parties
have quite different views. Sonoran has alleged a number of ways
in which PerkinElmer potentially breached this obligation. In
addition to PerkinElmer’s failure to retain Bogen, Sonoran
criticizes PerkinElmer’s decision to assign Guy Antley, an in-house
salesperson with no publishing experience, to lead the CTP sales
efforts on a part-time basis. Sonoran contends that Antley was
incompetent and made little effort to learn or promote the CTP
Business. Sonoran further contends that PerkinElmer “backed out of
its commitment to allow Donahue to run the business . . . and
started to operate it on the cheap.” Pls.-Appellants’ Br. 12.
Sonoran offers the expert testimony of Paul Baier, who stated that
despite a viable market for the CTP product, there was “very little
or no commitment to this product” from PerkinElmer executives.
Finally, Sonoran points to PerkinElmer’s alleged mishandling of a
potential opportunity to sell a large number of CTP units to
MacDermid, Inc., a dominant supplier of equipment to newspaper
publishers, as typical of the operation of the business.
PerkinElmer, on the other hand, asserts that in 2003 and
2004 alone it invested (and lost) $2.5 million per year of its own
money in the venture and vigorously attempted to promote and sell
the Sonoran product. In PerkinElmer’s view, the lack of success
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We note that in the complaint Donahue also argued that7
the Employment Agreement should be construed to include areasonable efforts provision. That agreement presents a moredifficult issue with respect to an implied reasonable effortsobligation. We need not, however, address this issue with respectto the Employment Agreement since Donahue has not sufficientlybriefed the issue on appeal. See United States v. Zannino, 895F.2d 1, 17 (1st Cir. 1990) (“It is not enough merely to mention apossible argument in the most skeletal way, leaving the court to docounsel’s work, create the ossature for the argument, and put fleshon its bones.”).
-20-
was attributable not to any lack of effort by PerkinElmer, but to
a lack of enthusiasm by prospective purchasers in investing in an
unproven technology and the well-known financial problems of the
newspaper industry.
PerkinElmer did not argue in its motion for summary
judgment that, if the reasonable efforts obligation applied, it was
entitled to summary judgment on the question of whether PerkinElmer
had in fact satisfied its reasonable efforts obligation. We
reverse and remand for the district court to determine whether
PerkinElmer breached this obligation with respect to the Purchase
Agreement——an issue to which we express no views. We recognize,7
as did the district judge, that PerkinElmer made a substantial
investment in Sonoran and therefore had a substantial interest in
making the CTP Business succeed, and so it may not be easy for
Sonoran to show a lack of reasonable efforts. Whether on remand a
trial is required to determine whether PerkinElmer utilized
reasonable efforts is a matter for the district court to consider.
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Def.-Appellee’s Br. 45 (“The District Court held that8
Sonoran’s implied covenant claim independently failed because ofSonoran’s failure to offer evidence of causation.”).
-21-
Finally, we note that PerkinElmer may argue that the
grant of summary judgment can be upheld on the ground that the
district court found a lack of causation and insufficient proof of
damages. To the extent that PerkinElmer makes such an argument,
PerkinElmer is incorrect. The district court on summary judgment
only addressed causation and damages with respect to the claims
relating to the covenants of good faith and fair dealing and
PerkinElmer’s alleged bad faith, as PerkinElmer appears to
recognize at various places in its brief. Causation and damages8
remain to be determined with respect to the reasonable efforts
claim if Sonoran is successful in establishing a breach of that
obligation. Again, whether on remand a trial is required to
determine causation and damages is a matter for the district court.
D. Violation of Chapter 93A
Finally, Sonoran asserts that PerkinElmer violated
Chapter 93A, Mass. Gen. Laws ch. 93A § 11. Chapter 93A creates a
cause of action for unfair or deceptive acts or practices. The
specific allegation here is that PerkinElmer violated Chapter 93A
by: (1) making “almost no effort to develop, market, and sell
Sonoran’s CTP products”; (2) “promising to amend the earnout and
other incentive payment clauses in the contract”; and (3)
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-22-
misrepresenting its intention to “develop a strong marketing and
sales program” for the CTP Business through the end of 2003. In
considering PerkinElmer’s motion for summary judgment on this
claim, the district court noted: “[t]o the extent a party’s Chapter
93A claims are based only on failed common law or statutory
grounds, several courts have refused to find Chapter 93A
liability.” Sonoran, 590 F. Supp. 2d at 212 (citations omitted).
It then granted PerkinElmer judgment as a matter of law on the
claim because “the Plaintiffs [Chapter 93A] claims derive entirely
from the same set of operative facts as their failed common law
grounds.” Id. In addition, PerkinElmer sought summary judgment on
the alternative ground that the pertinent events did not occur
primarily and substantially in Massachusetts, as Chapter 93A
requires. We agree with PerkinElmer’s alternative argument and
need not reach the issue addressed by the district court.
Chapter 93A states that:
No action shall be brought or maintained underthis section unless the actions andtransactions constituting the alleged unfairmethod of competition or the unfair ordeceptive act or practice occurred primarilyand substantially within the commonwealth.
Mass. Gen. Laws ch. 93A § 11 (emphasis added). Courts apply this
standard by considering the facts “in the context of the entire §
11 claim,” and then determining “whether the center of gravity of
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-23-
the circumstances that give rise to the claim is primarily and
substantially within the Commonwealth.” Kuwaiti Danish Computer
Corp. v. Digital Equip. Co., 781 N.E.2d 787, 799 (Mass. 2003); see
also Kenda Corp. v. Pot O’Gold Money Leagues, Inc., 329 F.3d 216,
234-35 (1st Cir. 2003).
Sonoran contends that the alleged Chapter 93A violations
occurred primarily and substantially in Massachusetts because
“[i]n-house counsel and Perkin Corporate, based in Massachusetts,
were intertwined with California employees and had the final say.
Massachusetts was in control of the negotiations and made all of
the important decisions.” Pls.-Appellants’ Br. 46. Sonoran
further asserts that PerkinElmer’s failure to make Bogen a better
offer and disclose the Lithography Division’s financial
difficulties occurred through PerkinElmer Corporate, located in
Massachusetts. We do not think this is sufficient for
Massachusetts to be the “center of gravity.”
In Bushkin Assoc., Inc. v. Raytheon Co., 473 N.E.2d 662
(Mass. 1985), a New York investment banker sued a Massachusetts
corporation under Chapter 93A, alleging that deceptive statements
were made to him in the course of telephone calls between
Massachusetts and New York. The Supreme Judicial Court of
Massachusetts determined that the alleged unfair or deceptive
conduct did not occur primarily in Massachusetts because, despite
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-24-
the fact that the allegedly deceptive phone calls were made from
Massachusetts, the telephone calls were received and acted upon in
New York and the plaintiffs’ losses were incurred in New York. Id.
at 672. As a result, the court rejected the Chapter 93A claim.
Id.
This case is similar to Bushkin. Just as the losses in
Bushkin did not occur in Massachusetts, Sonoran’s losses were
incurred in Arizona where Donahue and the CTP Business were
located. Sonoran also received and acted upon PerkinElmer’s
allegedly deceptive conduct in Arizona. Indeed this case is less
favorable to the plaintiffs than Bushkin. Unlike Bushkin, where
the allegedly deceptive statements were uttered in Massachusetts,
the alleged misconduct here occurred primarily in Arizona and
California where the Lithography and Optoelectronics Divisions were
located. The fact that the Purchase Agreement provided that
Massachusetts law would govern does not require a finding that the
center of gravity for Chapter 93A liability is in Massachusetts.
In Bushkin, the court determined that Massachusetts law controlled
(even without a clause explicitly providing so) but still found
that the alleged unfair or deceptive conduct did not occur
primarily and substantially in Massachusetts and thus that there
could be no Chapter 93A liability. Bushkin, 473 N.E.2d at 636,
638.
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-25-
Thus, viewing the record in the light most favorable to
Sonoran, PerkinElmer was entitled to summary judgment on the
Chapter 93A claim as the alleged unfair or deceptive conduct of
PerkinElmer did not occur primarily and substantially in
Massachusetts.
III. CONCLUSION
For the reasons set forth above, we reverse the judgment
of the district court with regard to whether the Purchase Agreement
contains an implied contractual term requiring PerkinElmer to use
reasonable efforts to develop and sell Sonoran’s CTP technology,
and remand for further proceedings on that issue. The judgment of
the district court is in all other respects affirmed. Each party
shall bear its own costs.
Affirmed-in-part, reversed-in-part, and remanded.
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IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
AIRBORNE HEALTH, INC. and WEIL, GOTSHAL & MANGES LLP
Plaintiffs,
v.
SQUID SOAP, LP
Defendant.
)))))))))
C.A. No. 4410-VCL
MEMORANDUM OPINION
Submitted: June 18, 2010 Decided: July 20, 2010
Joseph J. Bellew, Esquire, COZEN O’CONNOR, Wilmington, Delaware, Attorneys for
Plaintiff/Counterclaim Defendant Airborne Health, Inc.
William J. Wade, Esquire, Jeffrey L. Moyer, Esquire, David Schmerfeld, Esquire, Sarah R. Stafford, Esquire, RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware, Attorneys for Plaintiff/Counterclaim Defendant Weil, Gotshal & Manges LLP.
James S. Green, Sr., Esquire, Jared T. Green, Esquire, SEITZ, VAN OGTROP & GREEN, P.A., Wilmington, Delaware; Brian Smith, Esquire, DUNN LINDBERG SMITH LLP, Austin, Texas, Attorneys for Defendant/Counterclaim Plaintiff.
LASTER, Vice Chancellor.
EFiled: Jul 20 2010 2:09PM EDT Transaction ID 32227262 Case No. 4410-VCL
Plaintiffs Airborne Health, Inc. (“Airborne”) and Weil, Gotshal & Manges LLP
(“Weil”) have moved to dismiss the lone remaining counterclaim asserted by defendant
Squid Soap, LP (“Squid Soap”) for failure to state a claim on which relief can be granted.
Their motion is granted.
I. FACTUAL BACKGROUND
The current motion revisits an aspect of this case that I addressed in Airborne
Health, Inc. v. Squid Soap, LP, 984 A.2d 126 (Del. Ch. 2009) (the “Pleadings Decision”).
Airborne and Weil filed this action seeking a declaration that they had no liability to
Squid Soap and had complied with their obligations under an Asset Purchase Agreement
dated June 15, 2007 (the “APA”). Squid Soap responded with a barrage of
counterclaims. In the Pleadings Decision, I granted the plaintiffs’ Rule 12(c) motion and
entered a Rule 54(b) judgment in the plaintiffs’ favor on all of Squid Soap’s
counterclaims, including a counterclaim for extra-contractual fraud.
After I issued the Pleadings Decision, Squid Soap moved to modify the judgment.
Squid Soap asked that the dismissal be without prejudice as to its counterclaim for extra-
contractual fraud so that Squid Soap could re-plead that counterclaim with particularity. I
granted the motion, and Squid Soap filed a second amended answer and counterclaim
asserting only that claim (the “Amended Counterclaim”). Airborne and Weil have now
moved to dismiss the Amended Counterclaim pursuant to Rule 12(b)(6). The facts are
drawn from the well-pled allegations of the Amended Counterclaim.
1
A. A Refresher On Squid Soap
Squid Soap was formed to capitalize on John Lynn’s invention of a soap dispenser
that leaves a small spot of ink on a child’s hand that only can be removed after twenty
seconds of hand washing. Lynn named the product “Squid Soap.” The company and its
product enjoyed favorable early publicity, and major retailers like Wal-Mart, Target,
CVS, and Walgreen’s stocked Squid Soap.
In early 2007, various companies and investment groups approached Lynn seeking
to capitalize on Squid Soap’s potential, and Squid Soap began to explore its alternatives.
One suitor was Capital Southwest Corporation, a business development company. Squid
Soap’s discussions with Capital Southwest progressed to the point that Capital Southwest
suggested a candidate to run Squid Soap, Joseph Rainone. Capital Southwest also
suggested that Elise Donahue, then-CEO of Airborne, could add value as a Squid Soap
director. Lynn contacted Donahue, who decided instead to pursue Squid Soap for
Airborne.
B. The March 23 Telephone Call
Lynn’s first telephone call with Donahue took place on March 23, 2007. During
this call, Donahue said that she would prefer to buy Squid Soap rather than serve on its
board. To throw cold water on a potential deal with Capital Southwest, Donahue touted
Airborne’s marketing prowess, strong brand name, and perfect synergies with Squid
Soap. Donahue suggested that Airborne was a better fit for Squid Soap than Capital
Southwest, which only brought money to the table and was not a perfect strategic partner
like Airborne.
2
C. The New York Meeting
On April 4, 2007, Lynn and Greg Deisher, Squid Soap’s CEO, met with Donahue
and Rainone at the Le Parker Meridien Hotel in New York. During the meeting,
Donahue continued to make representations about Airborne, its marketing strength, its
brand name, and the benefits of putting the Airborne name on Squid Soap. She
represented that:
Airborne would use its very strong brand name to sell Squid Soap by putting Airborne’s name on Squid Soap’s packaging and by marketing Squid Soap beside Airborne on end caps in stores.
Airborne had great relationships with all the retailers in the United States where hygiene and soap products were sold, which Airborne would use along with its great name to get Squid Soap into retailers where Squid Soap was not currently being sold.
Airborne’s brand and customer loyalty made it the number one selling product on a unit basis in America in the cough and cold aisle.
The Airborne brand was very strong and would help to sell Squid Soap.
Airborne had the marketing expertise and resources to launch Squid Soap the right way.
D. The Bonita Springs Meeting
On April 10, 2007, Lynn and Deisher met with Donahue and Sonya Brown of
Summit Partners, Aiborne’s controlling stockholder, in Airborne’s offices in Bonita
Springs, Florida. Donahue repeated the representations made in her initial call with Lynn
and during the meeting in New York. She also pointed out that Airborne was the second
fastest growing company in America and a “marketing machine.”
3
E. The Letter of Intent
On May 8, 2007, a Weil partner emailed a letter of intent to Lynn. The letter of
intent contained the following representation:
The Airborne team’s experience in the consumer industry, our expertise in executing acquisitions, and our strong track record in supporting the growth and success of leading brands uniquely positions us as a great partner for [Squid Soap] and to leverage synergies with the Airborne brand. Moreover, an affiliation with our company would provide the ownership stability, strategic guidance, and financial resources necessary for [Squid Soap] to achieve its long-term goals.
The letter of intent was drafted by Weil and signed by Donahue.
F. The Addison Meeting
On May 9, 2007, the parties met at the Addison Marriott in Addison, Texas. The
Squid Soap attendees were Lynn, Deisher, and Steve Moats, Squid Soap’s Executive
Vice President of Sales. The Airborne attendees were Donahue, Tom Anderson,
Airborne’s Director of Sales – West, and Dave Kaplan, whose title and role the Amended
Counterclaim does not provide. Rainone also attended. At the meeting, Airborne’s
representatives made additional representations that included the following:
Airborne would use its very strong brand name to sell Squid Soap by putting Airborne on Squid Soap’s packaging and by marketing Squid Soap beside Airborne on end caps in stores.
Airborne had great relationships with all the retailers in the United States where hygiene and soap products were sold, which Airborne would use along with its great name to get Squid Soap into retailers where Squid Soap was not currently being sold.
Airborne’s brand and customer loyalty made it the number one selling product on a unit basis in America in the cough and cold aisle.
The Airborne brand was very strong and would help to sell Squid Soap.
4
Airborne had the marketing expertise and resources to launch Squid Soap the right way.
Airborne had the resources to launch Squid Soap like it deserved to be launched because it was an extremely profitable, virtual company with lots of revenue and very low fixed costs.
Partnering with Airborne would take Squid Soap to the next level.
G. The Target Presentation
On May 17, 2007, Airborne gave a Squid Soap-related PowerPoint presentation to
Target Corporation at Target’s corporate headquarters in Minneapolis, Minnesota. The
presentation was authored by Airborne and presented by Rainone, whom Airborne had
hired as President of its already-formed Squid Soap division. Anderson also attended for
Airborne. Moats attended for Squid Soap.
The Amended Counterclaim singled out four slides from the presentation. The
first bore the title “Airborne has unprecedented levels of customer loyalty.” It then listed
the following bullet points:
98% of Airborne users have recommended Airborne by name
Airborne has the #1, #2 and #10 SKU’s in the entire Cough/Cold category
96% of heavy users and 91% of regular users plan to buy the same or more Airborne over the next 12 months
Effectiveness is the #1 reason for repeat purchases (88% vs. 74% last year)
Brand awareness increased from 28% in 2005 to 49% in 2006 to 57% in 2007
Awarded a Top 50 Marketer by Advertising Age
5
The second bore the title “Airborne’s Truly Unique Marketing Has Created the
‘Airborne Buzz.’” The slide then listed the following bullet points:
Celebrity Endorsements
Late Night/ET Green Room Sampling
Sponsor Sundance Film Festival
Seasonal TV Media Tours
Website banners.
Airline Clubs sampling and In-Air Movie ads
Ski Lodge Pillow Top Samples and coupons.
Airport and Mass Transit Billboards.
Taxi Cab Toppers
Teachers Trust Fund
Traditional TV, FSI’s and more…….
The third slide bore the title “We’re redesigning our packaging.” It showed a
graphic of the new Squid Soap bottle, branded “Squid Soap by Airborne,” and stated:
New Airborne® branding brings trust and high levels of consumer awareness
Package shows product and provides consumer education of front panel
The fourth slide was titled “. . . and we’re ready to GROW!” It trumpeted the
“Marketing Power of Airborne,” including the ability to “Leverage Airborne’s loyal
consumer base,” “Drive trial and educate the consumer,” “Build pediatrician and doctor
support,” and “Create strong programs targeting ‘prevention.’” The slide also referred to
a “New products pipeline,” and listed as sub-bullets “Generating efficacy claims –
6
pandemic flu studies,” “Pursuing innovative new technologies,” and “Testing new
formulas.” The slide concluded, “Our goal is to drive category growth by bringing
innovation and efficacy to the soap aisle.”
H. The Witchita Falls Meeting
On May 24, 2007, Rainone flew to Dallas to visit Squid Soap’s distribution
facilities in Wichita Falls. Ron Mallonee, a principal of Squid Soap, picked up Rainone
from the airport in Dallas and drove him to Wichita Falls. During the two-hour drive and
subsequent tour of Squid Soap’s facilities, Rainone made representations to Mallonee,
including the following:
Airborne would put Squid Soap next to Airborne on end caps because Airborne’s strong brand name would be an immediate draw to Squid Soap.
Airborne would put significant money into advertising Squid Soap for the 2007 fall and winter flu season.
Airborne’s established market presence would get Squid Soap more out of every advertising dollar than Squid Soap could alone.
Airborne would make a family brand out of Squid Soap.
Airborne would develop other products from Squid Soap’s technology, such as a portable hand marker that a mother could carry in her purse to mark her child’s hand.
Airborne planned to capitalize on its established market presence and large advertising budget to grow Squid Soap beyond a single product and establish it as a family brand.
I. Telephone Conferences
In addition to the initial telephone call and meetings described above, the
Amended Counterclaim alleges that there were many telephone conferences between the
parties, including but not limited to calls on May 1, 2, and 7 and June 1, 2, 10, 11, and 12,
7
2007. During these calls, Airborne representatives, most often Donahue and Rainone,
made representations to Squid Soap’s representatives, including Lynn, Deisher,
Mallonee, and Moats. Sullivan and other Weil attorneys participated in several of the
telephone conferences.
In those calls, Airborne repeatedly represented that:
Airborne was the second fastest growing company in America and was a marketing machine.
Airborne would use its very strong brand name to sell Squid Soap by putting Airborne on Squid Soap’s packaging and by marketing Squid Soap beside Airborne on end caps in stores.
Airborne had great relationships with all the retailers in the United States where hygiene and soap products were sold, which Airborne would use along with its great name to get Squid Soap into retailers where Squid Soap was not currently being sold.
Airborne’s brand and customer loyalty made it the number one selling product on a unit basis in America in the cough and cold aisle.
The Airborne brand was very strong and would help to sell Squid Soap.
Airborne had the marketing expertise and resources to launch Squid Soap the right way.
Airborne would take Squid Soap and turn it into a household name.
Airborne had the resources to launch Squid Soap like it deserved to be launched because it was an extremely profitable, virtual company with lots of revenue and very low fixed costs.
Partnering with Airborne would take Squid Soap to the next level.
J. The Singular Basis For The Alleged Falsity Of All Of The Representations
Squid Soap contends that in reliance on Airborne’s repeated touting of its
marketing prowess, customer loyalty, positive brand-name recognition, and vision for
8
Squid Soap’s future, Squid Soap decided to enter into a deal with Airborne rather than
Capital Southwest or another suitor. Despite listing numerous representations during
multiple meetings and teleconferences, Squid Soap contends that all of Airborne’s
representations were false and misleading for a singular reason: Airborne failed to
disclose legal proceedings that threatened its continuing success.
Two pending proceedings allegedly rendered Airborne’s statements false and
misleading. The first was a class action against Airborne in California state court, filed in
May 2006, which asserted various claims for false or misleading advertising, consumer
fraud, deceptive or unfair business practices, concealment, omission, and unfair
competition (the “California Action”). The Center for Science in the Public Interest, a
non-profit organization with significant expertise in litigation over product mislabeling,
joined the California Action on the plaintiffs’ side. Weil was representing Airborne in
the California Action at the same time it was negotiating the APA for Airborne. On June
25, 2007, just ten days after the parties signed and closed on the APA, Weil removed the
California Action to federal court. In March 2008, nine months after signing the APA
with Squid Soap, Airborne settled the California Action for $23.5 million. Airborne also
agreed to place ads offering rebates in magazines such as Better Homes & Gardens,
Parade, People, and Newsweek. The settlement spawned an avalanche of adverse
publicity.
The second was a regulatory investigation. On March 8, 2005, the Federal Trade
Commission issued a “matter initiation notice” regarding an investigation of instances of
false marketing by Airborne. On February 22, 2007, the FTC issued a “civil
9
investigation demand.” After the media storm generated by the settlement of the
California Action, the FTC and the Attorneys General for thirty-two states sued Airborne
and its founders for false marketing. Airborne eventually agreed to a $30 million
settlement with the FTC and a $7 million settlement with the Attorneys General,
escrowed another $6.5 million for additional consumer claims, and committed to
completely revamp its marketing program. As part of the FTC settlement, Airborne
agreed to send a “Government Ordered Disclosure” to all of its distributors, resellers, and
retailers which recited that the FTC had charged Airborne with “making deceptive claims
for Airborne Effervescent Health Formula and other Airborne branded products” and that
“[a]ccording to the FTC, [Airborne] lacked scientific evidence that [its] products prevent
colds, protect against germs, . . . or protect against colds . . . .”
Squid Soap does not allege that Airborne affirmatively denied the existence of
these or other legal proceedings. Squid Soap also does not allege that Airborne made any
soft extra-contractual representations about legal proceedings or the absence thereof.
The only specific statement regarding litigation that Airborne made was a
representation in the APA. This representation stated only that “[t]here are no Legal
Proceedings pending or, to the Knowledge of Purchaser, threatened that are reasonably
likely to prohibit or restrain the ability of Purchaser to enter into this Agreement or
consummate the transactions contemplated hereby.” In the Pleadings Decision, I held
that by making this representation, Airborne represented only that there was not any
litigation affecting Airborne’s ability to sign the APA and close the deal. 984 A.2d at
10
138. Viewing the pleadings in the light most favorable to Squid Soap, I concluded that
Airborne’s representation in Section 6.3 was accurate. Id. at 140.
By contrast, the litigation representation that Airborne bargained for from Squid
Soap was much more broadly worded and categorically different from what Squid Soap
obtained from Airborne. It stated:
Except as set forth in Schedule 5.12, there is no Legal Proceeding pending or, to the Knowledge of [Squid Soap], threatened against [Squid Soap] (or to the Knowledge of [Squid Soap], pending or threatened, against any of the officers, directors or key Employees of [Squid Soap] with respect to their business activities on behalf of [Squid Soap]), or to which [Squid Soap] is otherwise a party, before any Governmental Body; nor to the Knowledge of [Squid Soap] is there any reasonable basis for any such Legal Proceeding.
This litigation representation addressed the existence of any “Legal Proceedings” of any
kind. As explained in the Pleadings Decision,
For this representation to be true, Squid Soap had to disclose on Schedule 5.12 any legal proceeding to which it was a party, or which it knew was threatened against it, or which it knew was pending or threatened against its officers, directors, or key employees and related to their business activities for Squid Soap. The representation is an example of the “informational” approach in which, “[i]n effect, the Company warrants that it has delivered a list of all litigation to the Buyer, but makes no representation as to how any of the disclosed lawsuits will come out, or the effect on the Company of losing one or more of them.” 2 Lou R. Kling & Eileen T. Nugent, Negotiated Acquisitions of Companies, Subsidiaries and Divisions § 11.04[10] at 11-60 (2001) (emphasis added).
984 A.2d at 137. Squid Soap negotiated the APA with the assistance of its counsel,
Vinson & Elkins. Id. at 144. Squid Soap did not obtain a broader representation.
11
K. Squid Soap Fails to Prosper.
After the closing of the APA, Squid Soap failed to prosper. Airborne entered into
the settlements described above. Airborne’s problems affected Squid Soap, now
rebranded as Squid Soap By Airborne. Squid Soap alleges that Airborne’s difficulties
“killed Squid Soap in its infancy.”
II. ANALYSIS
Dismissal under Rule 12(b)(6) is “inappropriate unless the ‘plaintiff would not be
entitled to recover under any reasonably conceivable set of circumstances susceptible of
proof.’” N. Am. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92,
97 (Del. 2007) (citing In re General Motors (Hughes) S’holder Litig., 897 A.2d 162, 168
(Del. 2006)). To survive a motion to dismiss, “a complaint must plead enough facts to
plausibly suggest that the [claimant] will ultimately be entitled to the relief [it] seeks.”
Desimone v. Barrows, 924 A.2d 908, 929 (Del. Ch. 2007) (citing Bell Atlantic Corp. v.
Twombly, 550 U.S. 544, 557 (2007)).
The Amended Counterclaim solely asserts a claim for extra-contractual common
law fraud. This claim requires “(1) a false representation of material fact; (2) made by a
person with knowledge that the representation is false, or with reckless indifference to the
truth; (3) an intention to induce the person to whom it made to act or refrain from acting
in reliance upon it; (4) causing that person, in justifiable reliance upon the false
statement, to take or refrain from taking action; (5) causing such person to suffer damage
by reason of such reliance.” Donald J. Wolfe, Jr. & Michael A. Pittinger, Corporate and
Commercial Practice in the Delaware Court of Chancery § 2.03[b][1], at 2-32 (2009).
12
There are three recognized species of common law fraud: (1) affirmative falsehoods, (2)
active concealment, and (3) silence in the face of a duty to speak. Metro Commc’n Corp.
BVI v. Advanced MobleComm Tech. Inc., 854 A.2d 121, 143 (Del. Ch. 2004) (citing
Stephenson v. Capano Dev., Inc., 462 A.2d 1069, 1074 (Del. 1983)). Squid Soap invokes
all three species of fraud.
Court of Chancery Rule 9(b) requires that “[i]n all averments of fraud . . ., the
circumstances constituting fraud . . . shall be stated with particularity.” In the Pleadings
Decision, I dismissed Squid Soap’s claim for extra-contractual fraud because its
allegations were “generalized and non-specific.” 984 A.2d at 142. The original
counterclaim did not identify “any person or the time, place, or contents of [any alleged]
misrepresentation.” Id. I quoted the following passage as a representative example of
Squid Soap’s generalized allegations:
Airborne made misrepresentations regarding its marketing prowess and ability, positive brand-name recognition, and the opportunities for joint marketing of Squid Soap under Airborne’s brand name. Airborne intentionally misrepresented, actively concealed, and failed to disclose facts and the truth about the value of its brand image, the impending downfall of its marketing and reputation, and the certain effect on its ability to market Squid Soap’s products. Airborne knew or should have known that the public allegations made against its products and marketing would not only devastate its brand name and customer loyalty—thereby sinking any products associated with Airborne—but would also drain Airborne of its resources and energy in recovering from the devastation.
Id. In the Amended Counterclaim, Squid Soap took seriously its pleading obligation to
provide “detail about what was actually said, who said it, where, [and] when.” Id. The
Amended Counterclaim provides this level of detail for multiple meetings and
13
teleconferences. But although Squid Soap’s Amended Counterclaim is now sufficiently
particularized, the allegations do not plead a claim for fraud.
A. Airborne Did Not Make A False Representation of Material Fact.
To the extent Squid Soap’s fraud claim relies on affirmative falsehoods, it fails
because Airborne did not make a false representation of material fact. Airborne did not
deny that it faced litigation. Nor did Airborne make any more general, but still inaccurate
statement about the type of litigation it faced. Outside of the accurate representation in
the APA, Airborne said nothing about litigation at all.
The statements that Airborne made were puffery. “Puffery is a ‘vague statement’
boosting the appeal of a service or product that, because of its vagueness and
unreliability, is immunized from regulation.” David A. Hoffman, The Best Puffery
Article Ever, 91 Iowa L. Rev. 1395, 1397 (2006). Under Delaware law, a company’s
optimistic statements praising its own “skills, experience, and resources” are “mere
puffery and cannot form the basis for a fraud claim.” Solow v. Aspect Res., LLC, 2004
WL 2694916, at *3 (Del. Ch. Oct.19, 2004)
The bullet points set forth in the Factual Background repeat virtually verbatim the
allegations of Squid Soap’s Amended Counterclaim. As those bullet points show, the
allegedly fraudulent statements made by Airborne amount to nothing more than vague
statements of corporate optimism designed to boost the appeal of Airborne as a potential
transaction partner for Squid Soap. For instance, Airborne bragged about its “very strong
brand name,” “established market presence,” and “unprecedented levels of customer
loyalty.” These are classically vague statements that a commercial party routinely makes
14
during deal-making courtship. See, e.g., Winner Acceptance Corp. v. Return on Capital
Corp., 2008 WL 5352063, at *8 (Del. Ch. Dec. 23, 2008) (holding statements to be “mere
pun and puffery” where defendant “promised that with his expertise and management he
would expand the mail business” and that existing “postal business and the Fleet were
just a ‘postage stamp of [what the defendant could] orchestrate this mail business to
be’”); Lazard Debt Recovery GP, LLC. v. Weinstock, 864 A.2d 955, 971 (Del. Ch. 2004)
(holding statements in which party touted its “ideal work environment” and “unique
resources” to be “at best enthusiastic puffery that no rational prospective investor . . .
would find material”). A sophisticated seller like Squid Soap, advised by expert counsel,
could not reasonably rely on Airborne’s boasts and blandishments.
B. Airborne Did Not Engage In Active Concealment.
To the extent Squid Soap claims fraud based on active concealment, it fails
because Squid Soap has not alleged facts supporting a plausible inference that Airborne
actively concealed information about pending litigation. Squid Soap alleges in
conclusory fashion that Airborne “hid” and “fraudulently concealed” the California
Action and regulatory investigation. Squid Soap particularly takes umbrage at the post-
closing removal of the California Action, decrying it as “reek[ing] of intentional deceit
and concealment.”
Squid Soap does not support these conclusory assertions with any pled facts. The
California Action was a matter of public record. Squid Soap could have performed a
litigation search. Or Squid Soap readily could have learned about all of Airborne’s
15
litigation exposure through the simple expedient of asking Airborne. The Amended
Counterclaim does not allege that Squid Soap asked.
The absence of inquiry is telling. Squid Soap did not chance upon Airborne as a
callow bumpkin ripe for the big city grifter. Squid Soap explored strategic alternatives
with the assistance of a well-known and sophisticated law firm. Squid Soap then selected
Airborne as its transaction partner, conducted the due diligence that Squid Soap and its
counsel deemed adequate, and negotiated the APA.
Parties engaging in M & A activity with the assistance of AmLaw 100 law firms
ask questions. Firms like Vinson & Elkins have lengthy, itemized questionnaires called
due diligence checklists that are sent to the other side in the course of a deal. In 2007,
sample checklists were readily available in practitioners’ pieces and in treatises on due
diligence, and likely could be found (as today) on the internet.1
If Squid Soap had asked about litigation and was not told about the California
Action or the regulatory proceedings, then Airborne would have a problem. If Squid
Soap sent over a due diligence checklist and the litigation information was withheld,
there would be a claim. If Airborne had made a misleading partial disclosure or offered a
half-truth designed to put Squid Soap off the scent, then the motion to dismiss would be
1See, e.g., John F. Seegal, 2007 Initial Due Diligence Checklist, in Acquiring or
Selling the Privately Held Company, 1610 PLI Corp. 365 (2007); see generally PeterHowson, Due Diligence (2003); Alexandra Reed Lajoux & Charles M. Elson, The Art of
M&A Due Diligence (2000); Gordon Bing, Due Diligence Techniques and Analysis
(1996); cf. Buying A Business: Due Diligence Checklist, http://smallbusiness.findlaw.com/business-forms-contracts/be3_8_1.html (last visited July 18, 2010).
16
denied. Under any of those circumstances, a court could infer active concealment at the
pleadings stage. The Amended Counterclaim does not describe any of these scenarios.
Not volunteering when not asked is not active concealment.
C. Airborne Had No Duty To Speak.
To the extent Squid Soap claims fraud grounded on silence in the face of a duty to
speak, it fails because Airborne did not labor under any duty of that sort. Airborne was
an arms’ length counter-party negotiating across the table from Squid Soap. Airborne
had no affirmative disclosure obligation. See Property Assoc. 14 v. CHR Holding Corp.,
2008 WL 963048, at *6 (Del.Ch. April 10, 2008) (holding that in the absence of a special
relationship, one party to a contract is under no duty to disclose “‘facts of which he
knows the other is ignorant’” even if “‘he further knows the other, if he knew of them,
would regard [them] as material in determining his course of action in the transaction in
question’”) (quoting Restatement (Second) of Torts § 551 cmt. a (1977)).
Airborne also did not assume a disclosure obligation under a partial disclosure
theory. A partial disclosure may be technically true yet actionably misleading. See
Norton v. Poplos, 443 A.2d 1, 5 (Del. 1982) (“[A]lthough a statement or assertion may be
facially true, it may constitute an actionable misrepresentation if it causes a false
impression as to the true state of affairs, and the actor fails to provide qualifying
information to cure the mistaken belief.”). The Amended Counterclaim does not identify
any actionably misleading partial disclosure about litigation that would tend to create a
false impression. Puffing about business prowess does not do the trick.
17
Contrary to Squid Soap’s arguments, the representation that Squid Soap bargained
for in the APA was not a partial disclosure. It was the specific information that Squid
Soap (with Vinson & Elkins’ assistance) obtained. That representation was accurate.
Pleadings Decision, 984 A.2d at 140. By not bargaining for a broader representation,
Squid Soap assumed the risk that its due diligence into litigation might be inadequate.
The limited litigation representation did not give rise to an affirmative duty to speak.
III. CONCLUSION
Squid Soap has failed to plead a claim for extra-contractual fraud against
Airborne. Lacking an underlying wrong, Squid Soap’s claims against Weil for aiding
and abetting and conspiracy likewise fail. The Amended Counterclaim is dismissed with
prejudice. IT IS SO ORDERED.
18
RECOMMENDED FOR FULL-TEXT PUBLICATIONPursuant to Sixth Circuit Rule 206
File Name: 09a0346p.06
UNITED STATES COURT OF APPEALSFOR THE SIXTH CIRCUIT
_________________
CINCOM SYSTEMS, INC., Plaintiff-Appellee,
v.
NOVELIS CORP., Defendant-Appellant.
X---->,---N
No. 07-4142
Appeal from the United States District Courtfor the Southern District of Ohio at Cincinnati.
No. 05-00152—Susan J. Dlott, Chief District Judge.
Argued: September 8, 2008
Decided and Filed: September 25, 2009
Before: BOGGS, GIBBONS, and GRIFFIN, Circuit Judges.
_________________
COUNSEL
ARGUED: Irene C. Keyse-Walker, TUCKER, ELLIS & WEST LLP, Cleveland, Ohio, forAppellant. Joseph Michael Callow, Jr., KEATING, MUETHING & KLEKAMP, PLL,Cincinnati, Ohio, for Appellee. ON BRIEF: Irene C. Keyse-Walker, Henry E. BillingsleyII, Karen E. Ross, TUCKER, ELLIS & WEST LLP, Cleveland, Ohio, for Appellant. JosephMichael Callow, Jr., James Eugene Burke, Jennifer J. Morales, KEATING, MUETHING &KLEKAMP, PLL, Cincinnati, Ohio, for Appellee.
_________________
OPINION_________________
JULIA SMITH GIBBONS, Circuit Judge. Novelis Corporation appeals from the
order of the district court granting summary judgment to plaintiff Cincom Sysems, Inc.
(“Cincom”), on its claim of copyright infringement. See 17 U.S.C. § 501. Novelis argues
that the district court erred by concluding that a series of mergers Novelis underwent as part
of an internal corporate restructuring resulted in a prohibited transfer of the software license
1
No. 07-4142 Cincom Sys., Inc. v. Novelis Corp. Page 2
Cincom had granted to a former Novelis subsidiary. Finding that our prior decision in PPG
Industries, Inc. v. Guardian Industries Corp., 597 F.2d 1090 (6th Cir. 1979), governs
Novelis’s appeal, we agree with the district court that Novelis’s actions led to an
impermissible transfer of the software license and accordingly affirm its judgment.
I.
Cincom is an Ohio-based corporation that develops, licenses, and services software
for its corporate customers. The rights to use two of Cincom’s most popular software
offerings form the basis of the current dispute. SUPRA© is a database management program
that allows a corporation to manage millions of records. MANTIS© is a fourth-generation
application development system, i.e., a computer language that allows a corporation’s
software professionals to develop computer programs that allow the corporation’s operations
to function more smoothly. Cincom is the sole owner of all rights to both the SUPRA© and
MANTIS© software. Rather than sell the computer programs themselves, Cincom only sells
licenses that allow its customers to use the two programs for an annual fee.
On July 5, 1989, Cincom agreed to license SUPRA© and MANTIS© to Alcan
Rolled Products Division (“Alcan Ohio”), an Ohio-based corporation that would later
become known as Novelis. The license Cincom issued listed “Alcan Rolled products [sic]
Division” as the “Customer” and granted to Alcan Ohio “a non-exclusive and non-
transferable license” to use Cincom’s software. (License at 1.) The license agreement
clarified that the two software programs “constitute proprietary and confidential information
of Cincom and that the protection of this information is of the highest importance.” (License
at 2.) Consequently, Alcan Ohio could only place the software on designated computers that
the parties specifically listed in a schedule attached to the license. (License at 1.) Alcan
Ohio listed the designated computer as one located at its facility in Oswego, New York. The
license agreement closed by noting that Ohio law would govern its terms and that Alcan
Ohio could “not transfer its rights or obligations under this Agreement without the prior
written approval of Cincom.” (License at 3.)
Before the commencement of Alcan Ohio’s internal reorganization, Alcan Ohio was
a wholly-owned subsidiary of Alcan, Inc., a Canadian corporation. On May 15, 2003, Alcan
Ohio created a separate corporation known as Alcan of Texas (“Alcan Texas”), organized
No. 07-4142 Cincom Sys., Inc. v. Novelis Corp. Page 3
under the laws of Texas. Alcan Texas, like Alcan Ohio, was also a wholly-owned subsidiary
of the Canadian parent corporation Alcan, Inc. On July 30, 2003, Alcan Ohio merged into
Alcan Texas, with Alcan Texas remaining as the surviving corporate entity. The next day,
Alcan Texas simultaneously merged into itself and its three Texas subsidiaries. As a result,
the former rolled products division of Alcan Ohio became a subsidiary of Alcan Texas
known as Alcan Fabrication Corporation. In September 2003, Alcan Fabrication
Corporation changed its name to Alcan Aluminum Corporation. A final name change
occurred on January 1, 2005, when Alcan Aluminum Corporation changed its name to its
current appellation, Novelis. Thus, as of January 2005, the software Alcan Ohio licensed
from Cincom remained on the same computer in Oswego, New York, but in a plant now
owned by an entity named Novelis. Alcan Ohio never sought or obtained Cincom’s written
approval to continue to use the SUPRA© and MANTIS© software before restructuring its
rolled products division.
Upon learning of the corporate changes Alcan Ohio underwent, Cincom filed suit
on March 11, 2005, in the United States District Court for the Southern District of Ohio,
alleging that Novelis’s actions violated the license agreement Cincom entered with Alcan
Ohio. Following discovery, the parties agreed upon stipulated facts and filed separate
motions for summary judgment. The district court determined that Alcan Ohio’s merger
with Alcan Texas effected a transfer of the license under Ohio law. Cincom Sys., Inc. v.
Novelis Corp., No. 1:05cv152, 2007 U.S. Dist. LEXIS 2721, at *19-20 (S.D. Ohio Jan. 12,
2007). Because Novelis had failed to distinguish our prior holding in PPG, the district court
entered summary judgment as to liability for Cincom. Id. at *19-20. The district court
certified its conclusion as involving a controlling question of law as to which substantial
ground for disagreement existed so that the parties could seek an interlocutory appeal of the
court’s order. Id. at *20; see 28 U.S.C. § 1292(b). We denied Novelis’s application for
permission to appeal. In re Novelis Corp., No. 07-0302, slip op. at 2 (6th Cir. Apr. 20,
2007). The parties then agreed to an order stipulating the amount of damages Cincom had
suffered as $459,530.00, equal to the amount of Cincom’s initial licensing fee. The district
No. 07-4142 Cincom Sys., Inc. v. Novelis Corp. Page 4
1Novelis and Cincom also agreed that each litigant would bear its own attorneys’ fees, despitethe language of the licensing agreement allowing the prevailing party to have its attorneys’ fees paid bythe unsuccessful party.
court approved the order on August 2, 2007.1 Novelis timely appealed the district court’s
final judgment.
II.
We review a district court’s grant of a summary judgment motion de novo. Smith
Wholesale Co. v. R.J. Reynolds Tobacco Co., 477 F.3d 854, 861 (6th Cir. 2007).
Summary judgment is appropriate where there are no genuine issues of material fact in
dispute, and one party is entitled to judgment as a matter of law. Fed. R. Civ. P. 56(c).
The moving party may meet its burden by “‘showing’ . . . that there is an absence of
evidence to support the nonmoving party’s case.” Celotex Corp. v. Catrett, 477 U.S.
317, 325 (1986). A trial is required only when “there are any genuine factual issues that
properly can be resolved only by a finder of fact because they may reasonably be
resolved in favor of either party.” Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 250
(1986). Summary judgment is “an integral part of the Federal Rules as a whole, which
are designed ‘to secure the just, speedy, and inexpensive determination of every action’”
rather than a “disfavored procedural shortcut.” Celotex, 477 U.S. at 327 (quoting Fed.
R. Civ. P. 1). Because both parties stipulated to the necessary facts and only issues of
law remain, this case is especially suited for summary disposition.
Novelis argues on appeal that the district court erred in granting summary
judgment to Cincom for two reasons. First, Novelis asserts that the district court
misinterpreted our prior holding in PPG by failing to look at the individual contracting
parties’ intent as expressed in the licensing agreement. Novelis claims that while the
agreement at issue in PPG showed a clear intent to prevent the license from coming into
the possession of a competitor, Cincom’s license demonstrates no concern with
preventing internal corporate reorganizations. Second, Novelis claims that a change in
Ohio substantive corporate law since our PPG decision, as demonstrated by state cases
interpreting the new language, requires us to find that no transfer of the license occurred
No. 07-4142 Cincom Sys., Inc. v. Novelis Corp. Page 5
2In copyright cases such as this, we refer to the case law interpreting patent law “because of thehistoric kinship between patent law and copyright law.” Sony Corp. of Am. v. Universal City Studios, Inc.,464 U.S. 417, 439 (1984).
as a result of Alcan Ohio’s merger with Alcan Texas. We will consider each argument
Novelis advances in turn.
A.
In PPG, we addressed the question of “whether the surviving or resultant
corporation in a statutory merger acquires patent license rights of the constituent
corporations.”2 597 F.2d at 1091. PPG involved two glass fabrication corporations that
had developed a new industrial process for shaping glass for various commercial uses.
Id. PPG granted a “non-exclusive, non-transferable” license to the Permaglass
Corporation to use this new “gas hearth technology.” Id. at 1091-92. The license further
noted that the grant to Permaglass was “personal to PERMAGLASS and non-assignable
except with the consent of PPG first obtained in writing.” Id. at 1092. Despite this
language, Permaglass merged with Guardian Industries, a corporation that manufactured
windshields for automobiles. Id. Under the laws of Delaware and Ohio, which governed
the merger, Permaglass’s licenses would automatically transfer to and vest in the
successor corporation, Guardian Industries. Id. at 1095-96. We concluded that in the
context of intellectual property, a license is presumed to be non-assignable and non-
transferable in the absence of “express provisions to the contrary.” Id. at 1095. Because
this was a mandate of federal law, Ohio law could not override this presumption. Id. at
1093. We therefore reversed the district court and ordered judgment entered in favor of
PPG. Id. at 1097.
1.
We have had no occasion to consider our holding in PPG since its original
issuance in 1979. Consequently, we take this opportunity to explain more fully the
complex interaction of federal and state law that occurs when interpreting intellectual
property licenses. Federal common law governs “questions with respect to the
assignability of a patent [or copyright] license.” Id. at 1093. While the Supreme Court
No. 07-4142 Cincom Sys., Inc. v. Novelis Corp. Page 6
famously declared in Erie Railroad Co. v. Tompkins, 304 U.S. 64, 78 (1938), that
“[t]here is no federal general common law,” there are “limited . . . situations where there
is a significant conflict between some federal policy or interest and the use of state law”
that require “judicial creation of a special federal rule” of common law. O’Melveny &
Myers v. Fed. Deposit Ins. Corp., 512 U.S. 79, 87 (1994) (internal quotation marks and
citations omitted). Such a special rule clearly is justified in the realm of intellectual
property because “[t]he fundamental policy of the patent system is to ‘encourage the
creation and disclosure of new, useful, and non-obvious advances in technology and
design’ by granting the inventor the reward of ‘the exclusive right to practice the
invention for a period of years.’” Everex Sys., Inc. v. Cadtrak Corp. (In re CFLC, Inc.),
89 F.3d 673, 679 (9th Cir. 1996) (quoting Bonito Boats, Inc. v. Thunder Craft Boats,
Inc., 489 U.S. 141, 150-51 (1989)). Allowing state law to permit the free assignability
of patent or copyright licenses would “undermine the reward that encourages invention.”
Id. This is because any entity desiring to acquire a license could approach either the
original inventor or one of the inventor’s licensees. Absent a federal rule of decision,
state law would transform every licensee into a potential competitor with the patent or
copyright holder. In such a world, the holder of a patent or copyright would be
understandably unwilling to license the efforts of his work, thereby preventing
potentially more efficient uses of the invention by others. See id.; cf. Rhone-Poulenc
Agro S.A. v. DeKalb Genetics Corp., 284 F.3d 1323, 1328 (Fed. Cir. 2002) (“[C]ourts
generally have acknowledged the need for a uniform national rule that patent licenses
are personal and non-transferrable in the absence of an agreement authorizing
assignment.”).
Despite the federal common law rule that copyright licenses are unassignable
absent express language to the contrary, “[s]tate law is not displaced merely because the
contract relates to intellectual property.” Aronson v. Quick Point Pencil Co., 440 U.S.
257, 262 (1979). The states are thus “free to regulate the use of . . . intellectual property
in any manner not inconsistent with federal law.” Id. Applying these principles, state
contract law will govern the interpretation of a license because a license is merely a type
of contract. In re CFLC, 89 F.3d at 677; see also Power Lift, Inc. v. Weatherford Nipple-
No. 07-4142 Cincom Sys., Inc. v. Novelis Corp. Page 7
3It is undisputed that Novelis gave no notification to Cincom of its plans to merge Alcan Ohioout of existence as a part of its restructuring.
4We once again emphasize that even if the license were silent as to the issue of transfers, federalcommon law would serve to fill the gap with its default rule that no transfer is allowed without expressauthorization. See PPG, 597 F.2d at 1093. Here, however, the express wording of the license itselfprohibited unauthorized transfers so that simple contract construction under state law provides the answer.
Up Sys., Inc., 871 F.2d 1082, 1085-86 (Fed. Cir. 1989) (noting that “a license agreement
is a contract governed by ordinary principles of state contract law”). As there is no
general federal corporate law, state law will also determine whether a merger results in
the transfer of an intellectual property license. However, where state law would allow
for the transfer of a license absent express authorization, state law must yield to the
federal common law rule prohibiting such unauthorized transfers. PPG, 597 F.2d at
1093; see also In re CFLC, Inc., 89 F.3d at 679 (federal law must govern to prevent free
assignability and to promote creativity); In re Alltech Plastics, Inc., 71 B.R. 686, 689
(Bankr. W.D. Tenn. 1987) (Because “[t]he rights of the patent owner to license the use
of his invention is [sic] a creature of federal common law . . . . [i]t follows that questions
regarding the assignability of patent licenses are controlled by federal law.”).
2.
Novelis’s argument that we can distinguish our decision in PPG based upon the
specific intent of the contracting parties is incorrect. As in PPG, Cincom granted
Novelis a non-exclusive and non-transferrable license. Compare PPG, 597 F.2d at 1092,
with License at 1. Both the license at issue in PPG and the license issued to Novelis also
required the express written approval of the grantor prior to any transfer of the license.
Compare PPG, 597 F.2d at 1092, with License at 3. The plain text of the license is clear.
No transfers are permissible without express written approval.3 See Cincinnati Ins. Co.
v. CPS Holdings, Inc., 875 N.E.2d 31, 34 (Ohio 2007) (“When the language of a written
contract is clear, a court may look no further than the writing itself to find the intent of
the parties.”(citation omitted)).4
The fact that the license at issue in PPG ultimately found its way into the hands
of a competitor does not serve to distinguish our holding from the present set of facts.
No. 07-4142 Cincom Sys., Inc. v. Novelis Corp. Page 8
While it is true that the primary reason for the federal common law rule prohibiting the
transfer of a license without authorization is to prevent the license from coming into a
competitor’s possession, this does not translate into a rule of “no competitor possession,
no foul.” See In re CFLC, Inc., 89 F.3d at 679. The harm is the breach of the terms of
the license: the violation of the federal policy (or contract term) allowing the copyright
or patent holder to control the use of his creation. The fact that Novelis is not a
competitor of Cincom is therefore immaterial. PPG’s holding governs the resolution of
Cincom’s complaint. If Ohio law served to transfer the license from Alcan Ohio to
Novelis as a result of the internal merger, Novelis violated the express terms of its non-
transferable license. It is to that issue to which we now turn.
B.
Novelis argues that Ohio’s statutory merger law has changed since we first
considered its effect on intellectual property licenses thirty years ago. Novelis thus
reasons that our holding in PPG that Ohio’s merger law effects an impermissible transfer
of ownership in a license must change, as well. Cincom responds that the changes in
Ohio law are merely cosmetic and still result in an impermissible transfer of the license
it originally granted Alcan Ohio.
At the time of our decision in PPG, Ohio’s statutory merger law provided that
“all property of a constituent corporation shall be ‘deemed to be [t]ransferred to and
vested in the surviving or new corporation without further act or deed.’” PPG, 597 F.2d
at 1096 (quoting Ohio Rev. Code Ann. § 1701.81(A)(4) (1955)) (emphasis added). The
current statute provides:
The surviving or new entity possesses all assets and property of everydescription, and every interest in the assets and property, whereverlocated, and the rights, privileges, immunities, powers, franchises, andauthority, of a public as well as of a private nature, of each constituententity, and, subject to the limitations specified in section 2307.97 of theRevised Code, all obligations belonging to or due to each constituententity, all of which are vested in the surviving or new entity withoutfurther act or deed. Title to any real estate or any interest in the real
No. 07-4142 Cincom Sys., Inc. v. Novelis Corp. Page 9
estate vested in any constituent entity shall not revert or in any way beimpaired by reason of such merger or consolidation.
Ohio Rev. Code Ann. § 1701.82(A)(3) (2009) (emphasis added). Novelis argues that the
deletion of the prior statute’s language explaining that all property shall be deemed
“[t]ransferred to” the surviving corporation prevents a finding that Alcan Ohio’s merger
with Alcan Texas transferred the license. See Id. § 1701.81(A)(4) (1955). Our holding
in PPG did not hang by so slender a thread.
Ohio’s law provides that upon a merger, “[t]he separate existence of each
constituent entity other than the surviving entity . . . shall cease.” Id. § 1701.82(A)(1).
Alcan Ohio, the rightful holder of the Cincom license, thus no longer exists as a legal
entity under Ohio law. Ohio law further provides that the license once held by Alcan
Ohio automatically vested by operation of law in Novelis Corporation, Alcan Ohio’s
successor, after the completion of the corporate restructuring. See id. § 1701.82(A)(3).
The vesting of the license in the surviving entity could not occur without being
transferred by the old entity. As we explained in PPG, “A transfer is no less a transfer
because it takes place by operation of law rather than by a particular act of the parties.
The merger was effected by the parties and the transfer was a result of their act of
merging.” 597 F.2d at 1096. The deletion of the word transferred does not change this
analysis. Federal common law, and the actual language of the license in this case, is
clear: the only legal entity that can hold a license from Cincom is Alcan Ohio. If any
other legal entity holds the license without Cincom’s prior approval, that entity has
infringed Cincom’s copyright because a transfer has occurred. Simply put, in the context
of a patent or copyright license, a transfer occurs any time an entity other than the one
to which the license was expressly granted gains possession of the license. Id. at 1095-
96. Alcan Ohio no longer owns the plant in Oswego, New York, where the designated
computer licensed to contain Cincom’s software resides, because Alcan Ohio no longer
exists. Novelis now owns the plant and has possession of the license under Ohio law.
Consequently, Novelis has infringed upon Cincom’s copyright. Id. at 1096-97.
Further demonstrating that the deletion of the word “[t]ransferred” from the Ohio
statute does not change our analysis is the fact that the merger at issue in PPG actually
No. 07-4142 Cincom Sys., Inc. v. Novelis Corp. Page 10
5The Texas Court of Appeals further observed that the contracting parties could have foreseena merger and specifically prohibited a transfer in such an instance. TXO, 999 S.W.2d at 143. This isexactly the opposite of federal common law’s presumption of non-transferability in the event of a license’ssilence. Cf. PPG, 597 F.2d at 1093.
occurred under both Ohio and Delaware law. Delaware law, both in 1979 and today,
requires that all property of the constituent corporation “‘shall be vested in the
corporation surviving or resulting from such merger or consolidation.’” Id. at 1096
(quoting 8 Del. C. § 259(a)). We considered the difference in statutory language and
concluded that what matters for the purpose of determining whether the license actually
transferred is if the same legal entity held the license. Under either statute, the legal
entity holding the license changed; therefore, Guardian Industries infringed PPG’s
patent. Id. at 1096-97.
The state cases Novelis cites in its briefs do not force us to reconsider our
interpretation of Ohio law. In TXO Production Co. v. M.D. Mark Inc., 999 S.W.2d 137,
143 (Tex. App. 1999), a Texas court held that a merger of a subsidiary into its parent
corporation did not violate a non-assignability clause in a contract. The Texas court had
examined the substantially similar Texas, Ohio, and Delaware merger statutes, all of
which applied to the transaction, and explicitly rejected our opinion in PPG. Id. at 141-
42. However, as the Texas Court of Appeals noted, our opinion in PPG rested upon the
“strong public policy against the implied assignment of patent licenses.” Id. at 141 n.4.
The Texas contract at issue in TXO did not involve intellectual property, id., and
therefore instead fell into the general contract law principle that “courts disfavor
forfeiture.” Id. at 140. While the Texas court fretted that “a requirement that the
surviving corporation pay a fee in the event of a merger unnecessarily hinders the free
flow of those rights to the surviving corporation,” this is exactly the purpose of copyright
law – to prevent the “free flow” of information without the author’s permission. Id. at
142; see also In re CFLC, Inc., 89 F.3d at 679. TXO is therefore inapposite because it
does not address the effect of the Ohio merger statute in the context of intellectual
property.5
No. 07-4142 Cincom Sys., Inc. v. Novelis Corp. Page 11
ASA Architects, Inc. v. Schlegel, 665 N.E.2d 1083 (Ohio 1996), is similarly
unhelpful to Novelis. There the Ohio Supreme Court held that the contractual
obligations under a stock purchase agreement “flowed, by operation of law,” to the
successor corporation. Id. at 1089. We have found just the same. Ohio law causes the
license agreement to flow to Novelis following Alcan Ohio’s merger. The difference is
that because this contract involves a copyright license, such a transfer without
permission is inherently a breach of the contract. PPG, 597 F.3d at 1093; see also In re
CFLC, Inc., 89 F.3d at 679; Unarco Indus., Inc. v. Kelley Co., 465 F.2d 1303, 1306 (7th
Cir. 1972) (“[F]ederal law applies to the question of the assignability of the patent
license.”).
III.
When Alcan Ohio merged with Alcan Texas, the license granted by Cincom
solely to Alcan Ohio transferred to the surviving corporation, now known as Novelis.
Because Novelis did not abide by the express terms of Cincom’s license and gain
Cincom’s prior written approval, Novelis infringed Cincom’s copyright. We therefore
affirm the judgment of the district court.
IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
HEXION SPECIALTY CHEMICALS, )INC.; NIMBUS MERGER SUB INC.; )APOLLO INVESTMENT FUND IV, L.P.; )APOLLO OVERSEAS PARTNERS IV, )L.P.; APOLLO ADVISORS IV, L.P.; )APOLLO MANAGEMENT IV, L.P.; )APOLLO INVESTMENT FUN V, L.P.; )APOLLO OVERSEAS PARTNERS V, )L.P.; APOLLO NETHERLANDS )PARTNERS V(A), L.P.; APOLLO )NETHERLANDS PARTNERS V(B), )L.P.; APOLLO GERMAN PARTNERS V )GMBH & CO. KG; APOLLO ADVISORS )V, L.P.; APOLLO MANAGEMENT V, )L.P.; APOLLO INVESTMENT FUND VI, )L.P.; APOLLO OVERSEAS PARTNERS )VI, L.P.; APOLLO OVERSEAS )PARTNERS (DELAWARE) VI, L.P.; )APOLLO OVERSEAS PARTNERS )(DELAWARE 892) VI, L.P.; APOLLO )OVERSEAS PARTNERS (GERMANY) )VI, L.P.; APOLLO ADVISORS VI, L.P.; )APOLLO MANAGEMENT VI, L.P.; )APOLLO MANAGEMENT, L.P.; AND )APOLLO GLOBAL MANAGEMENT, )LLC, )
)Plaintiffs/Counterclaim Defendants, )
)v. ) C.A. No. 3841-VCL
)HUNTSMAN CORP., )
)Defendant/Counterclaim Plaintiff. )
EFiled: Sep 29 2008 5:00PM EDT Transaction ID 21756508 Case No. 3841-VCL
OPINION
Submitted: September 19, 2008
Decided: September 29, 2008
Donald J. Wolfe, Jr., Esquire, Stephen C. Norman, Esquire, Kevin R. Shannon,Esquire, Bradley W. Voss, Esquire, Abigail M. LeGrow, Esquire, Berton W.Ashman, Jr., Esquire, POTTER ANDERSON & CORROON LLP, Wilmington,Delaware; Peter C. Hein, Esquire, Marc Wolinsky, Esquire, Jeffrey C. Fourmaux,Esquire, David Gruenstein, Esquire, Douglas K. Mayer, Esquire Stephen R.DiPrima, Esquire, Graham W. Meli, Esquire, Paul K. Rowe, Esquire, Elaine P.Golin, Esquire, Andrew J. Cheung, Esquire, WACHTELL, LIPTON, ROSEN &KATZ, New York, New York; Vineet Bhatia, Esquire, SUSMAN GODFREY,LLP, Houston, Texas; Keith A. Call, Esquire, SNOW CHRISTENSEN &MARTINEAU, Salt Lake City, Utah, Attorneys for Plaintiffs/Counterclaim
Defendants.
Bruce L. Silverstein, Esquire, Rolin P. Bissell, Esquire, Danielle Gibbs, Esquire,Christian Douglas Wright, Esquire, Dawn M. Jones, Esquire, Kristen SalvatoreDePalma, Esquire, Tammy L. Mercer, Esquire, Richard J. Thomas, Esquire,YOUNG CONAWAY STARGATT & TAYLOR, LLP, Wilmington, Delaware;Harry M. Reasoner, Esquire, David T. Harvin, Esquire, John D. Taurman, Esquire,James A. Reeder, Jr., Esquire, N. Scott Fletcher, Esquire, Erica L. Krennerich,Esquire, Bruce A. Blefeld, Esquire, Michael C. Holmes, Esquire, VINSON &ELKINS, L.L.P., Houston, Texas; Alan S. Goudiss, Esquire, Jaculin Aaron,Esquire, SHEARMAN & STERLING LLP, New York, New York; Kathy D.Patrick, Esquire, Jeremy L. Doyle, Esquire, Laura J. Kissel, Esquire, Laurel R.Boatright, Esquire, GIBBS & BRUNS, L.L.P., Houston, Texas, Attorneys for
Defendant/Counterclaim Plaintiff.
LAMB, Vice Chancellor.
1
In July 2007, just before the onset of the ongoing crisis affecting the national
and international credit markets, two large chemical companies entered into a
merger agreement contemplating a leveraged cash acquisition of one by the other.
The buyer is a privately held corporation, 92% owned by a large private equity
group.
Because the buyer and its parent were eager to be the winning bidder in a
competitive bidding situation, they agreed to pay a substantially higher price than
the competition and to commit to stringent deal terms, including no “financing
out.” In other words, if the financing the buyer arranged (or equivalent alternative
financing) is not available at the closing, the buyer is not excused from performing
under the contract. In that event, and in the absence of a material adverse effect
relating to Huntsman’s business as a whole, the issue becomes whether the buyer’s
liability to the seller for failing to close the transaction is limited to $325 million by
contract or, instead, is uncapped.
The answer to that question turns on whether the buyer committed a
knowing and intentional breach of any of its covenants found in the merger
agreement that caused damages in excess of the contractual limit. Among other
things, the buyer covenanted that it would use its reasonable best efforts to take all
actions and do all things “necessary, proper or advisable” to consummate the
financing on the terms it had negotiated with its banks and further covenanted that
2
it would not take any action “that could be reasonably be expected to materially
impair, delay or prevent consummation” of such financing.
While the parties were engaged in obtaining the necessary regulatory
approvals, the seller reported several disappointing quarterly results, missing the
numbers it projected at the time the deal was signed. After receiving the seller’s
first quarter 2008 results, the buyer and its parent, through their counsel, began
exploring options for extricating the seller from the transaction. At first, this
process focused on whether the seller had suffered a material adverse effect. By
early May, however, attention shifted to an exploration of the prospective solvency
of the combined entity, leading them to retain the services of a well-known
valuation firm to explore the possibility of obtaining an opinion that the combined
entity would be insolvent. After making a number of changes to the inputs into the
deal model that materially and adversely effected the viability of the transaction,
and without consulting with the seller about those changes or about other business
initiatives that might improve the prospective financial condition of the resulting
entity, the buyer succeeded in obtaining an “insolvency” opinion.
The insolvency opinion was presented to the buyer’s board of directors on
June 18, 2008, and later published in a press release claiming that the merger could
not be consummated because the financing would not be available due to the
prospective insolvency of the combined entity and because the seller had suffered a
3
material adverse effect, as defined in the merger agreement. The buyer and a host
of its affiliated entities immediately filed the complaint in this action, alleging a
belief that the merger cannot be consummated since the financing will not be
available.
The complaint alleges financing will be unavailable because, (1) the
amounts available under that financing are no longer sufficient to close the
transaction and (2) the combined entity would be insolvent. The complaint seeks a
declaration that the buyer is not obligated to consummate the merger if the
combined company would be insolvent and a further declaration that its liability
(and that of its affiliates) to the seller for nonconsummation of the transaction
cannot exceed the $325 million termination fee. The complaint also seeks a
declaration that the seller suffered a material adverse effect, thus excusing the
buyer’s obligation to close. The seller answered and filed counterclaims seeking,
among other things, an order directing the buyer to specifically perform its
obligations under the merger agreement.
The court conducted six days of trial on certain of the claims for declaratory
and injunctive relief raised by the pleadings. In this post-trial opinion, the court
finds that the seller has not suffered a material adverse effect, as defined in the
merger agreement, and further concludes that the buyer has knowingly and
intentionally breached numerous of its covenants under that contract. Thus, the
4
court will grant the seller’s request for an order specifically enforcing the buyer’s
contractual obligations to the extent permitted by the merger agreement itself.
The court also determines that it should not now rule on whether the
combined entity, however it may ultimately be capitalized, would be solvent or
insolvent at closing. In this connection, the court rejects the buyer’s argument that
it can be excused from performing its freely undertaken contractual obligations
simply because its board of directors concluded that the performance of those
contractual obligations risked insolvency. Instead, it was the duty of the buyer’s
board of directors to explore the many available options for mitigating the risk of
insolvency while causing the buyer to perform its contractual obligations in good
faith. If, at closing, and despite the buyer’s best efforts, financing had not been
available, the buyer could then have stood on its contract rights and faced no more
than the contractually stipulated damages. The buyer and its parent, however,
chose a different course.
The court recognizes that there remain substantial obstacles to closing the
transaction. Some of those result from the current unsettled credit environment,
others result from the difficult macroeconomic conditions facing both the seller
and the buyer in running their businesses. Some other of those obstacles appear to
result from the course of action the buyer and its parent have pursued in place of
the continued good faith performance of the buyer’s contractual obligations.
5
Despite these obstacles, the seller has asked for an order of specific performance
and, given the realistic possibility that the buyer and its parent may now regard
closing the deal to be a superior outcome to not closing, the court concludes that
such an order should issue requiring Hexion to perform all of its covenants and
obligations (other than the ultimate obligation to close).
I.
A. The Parties
The plaintiffs and counterclaim defendants in this action are Hexion
Specialty Chemicals, Inc., Apollo Global Management, LLC, and various entities
through which Apollo Global Management conducts its business (Apollo Global
Management and its related entities are collectively referred to as “Apollo”).
Hexion, a New Jersey corporation, is the world’s largest producer of binder,
adhesive, and ink resins for industrial applications. Apollo Global Management, a
Delaware limited liability company, is an asset manager focusing on private equity
transactions. Through its ownership in Hexion’s holding company, Apollo owns
approximately 92% of Hexion.
The defendant and counterclaim plaintiff in this action is Huntsman
Corporation, a Delaware corporation. Huntsman, a global manufacturer and
marketer chemical products, operates five primary lines of business:
1 Apollo is not a party to the merger agreement.
6
Polyurethanes, Advanced Materials, Textile Effects, Performance Products and
Pigments.
B. Procedural History
On July 12, 2007, Hexion and Huntsman signed a merger agreement
whereby Hexion agreed to pay $28 per share in cash for 100% of Huntsman’s
stock.1 The total transaction value of the deal was approximately $10.6 billion,
including assumed debt. The plaintiffs filed suit in this court on June 18, 2008
seeking declaratory judgment on three claims: (1) Hexion is not obligated to close
if the combined company would be insolvent and its liability to Huntsman for
failing to close is limited to no more than $325 million; (2) Huntsman has suffered
a Company Material Adverse Effect (“MAE”); and (3) Apollo has no liability to
Huntsman in connection with the merger agreement. On July 2, 2008, Huntsman
filed its answer and counterclaims requesting declaratory judgment that:
(1) Hexion knowingly and intentionally breached the merger agreement;
(2) Huntsman has not suffered an MAE; and (3) Hexion has no right to terminate
the merger agreement. Also, Huntsman’s counterclaims seek an order that Hexion
specifically perform its obligations under various sections of the merger
agreement, or, alternatively, and in the event Hexion fails to perform, the award of
full contract damages.
2 Am. Compl. ¶ 147 and 153. Leon Black and Joshua Harris are partners at Apollo.
7
Hexion amended its complaint on July 7, 2008 to request declaratory
judgment that Huntsman’s decision to extend the termination date from July 4,
2008 to October 2, 2008 was invalid and that Huntsman breached the forum
selection clause of the merger agreement by suing Apollo, Leon Black. and Joshua
Harris in Texas on June 23, 2008.2 Hexion also asks the court to enjoin Huntsman
from asserting or prosecuting claims related to the merger agreement in other
forums, including a specific request to enjoin the Texas lawsuit. On July 9, 2008,
the court granted Huntsman’s motion for expedited proceedings on limited issues.
Huntsman filed its amended answer on July 14, 2008. On August 5, 2008, the
court further refined the issues to be tried during the expedited proceedings.
Beginning on September 8, 2008, a six-day trial was held on Huntsman’s
counterclaims and counts I (damages limited to $325 million), II (material adverse
effect), and IV (invalid extension of termination date) of Hexion’s amended
complaint.
C. Negotiations Between The Parties In 2005 And 2006
In late 2005 and early 2006, Apollo and Hexion entered negotiations with
Huntsman concerning a proposed transaction whereby Hexion would merge with
Huntsman’s specialty chemical business and Huntsman’s commodity business
would be spun out and acquired by Apollo. Hexion and Apollo performed
3 Huntsman witnesses characterized Apollo’s termination of negotiations as backing out at theeleventh hour.4 A transaction between Huntsman and Hexion would take longer to close because it required amore detailed antitrust review than a deal between Huntsman and Basell. Also, the proposedtransaction with Hexion would be more highly levered than the proposed transaction with Basell. Joint Pretrial Stipulation and Order 5.
8
substantial due diligence on Huntsman, but the deal died when Huntsman missed
earnings targets and Apollo advised Huntsman that it could no longer justify the
$25 per share price then being discussed.3
D. 2007 Negotiations Leading To July 12, 2007 Merger Agreement
In May 2007, Huntsman, through its financial advisor Merrill Lynch & Co.,
Inc., began to solicit bids for the company. Apollo (through Hexion) and Basell,
the world’s largest polypropylene maker, emerged among the potential buyers.
Huntsman signed confidentiality agreements and began to negotiate merger
agreements with both Hexion and Basell. On June 25, 2007, Huntsman rejected
Hexion’s offer of $26 per share and executed a merger agreement with Basell for
$25.25 per share. The same day, but after the agreement was signed, Hexion raised
its bid to $27 per share. Basell refused to raise its bid, stating that its deal
remained superior because it was more certain to close.4 On June 29, 2007,
Huntsman re-entered negotiations with Hexion after Hexion further increased its
bid to $27.25 per share. On July 12, 2007, Huntsman terminated its deal with
Basell and signed an all cash deal at $28 per share with Hexion.
5 Huntsman negotiated for the right to have its Chief Financial Officer provide the solvencycertificate.
9
E. The Financing
One day before the signing of the merger agreement, Hexion signed a
commitment letter with affiliates of Credit Suisse and Deutsche Bank (the “lending
banks”) to secure financing for the deal. In section 3.2(e) of the merger agreement,
Hexion represented that the “aggregate proceeds contemplated to be provided by
the Commitment Letter will be sufficient . . . to pay the aggregate Merger
Consideration.” The commitment letter required a “customary and reasonably
satisfactory” solvency certificate from the Chief Financial Officer of Hexion, the
Chief Financial Officer of Huntsman, or a reputable valuation firm as a condition
precedent to the lending banks obligation to provide financing.5
F. July 12, 2007 Merger Agreement
Due to the existence of a signed agreement with Basell and Apollo’s
admittedly intense desire for the deal, Huntsman had significant negotiating
leverage. As a result, the merger agreement is more than usually favorable to
Huntsman. For example, it contains no financing contingency and requires Hexion
to use its “reasonable best efforts” to consummate the financing. In addition, the
agreement expressly provides for uncapped damages in the case of a “knowing and
intentional breach of any covenant” by Hexion and for liquidated damages of
6 Trial Tr. vol. 1, 232.7 The same presentation reads that Hexion or Huntsman have the leading market position in theworld in 12 major products. Furthermore the presentation describes the global diversification ofHuntsman and how Huntsman’s strength in Asia complemented Hexion’s strength in LatinAmerica.8 One of Apollo’s models showed returns of approximately 11% to 18% after five years on theHuntsman transaction. Apollo published in its investors memorandum in June 2007 that itexpected returns of 27% to 32% over the same time period.
10
$325 million in cases of other enumerated breaches. The narrowly tailored MAE
clause is one of the few ways the merger agreement allows Hexion to walk away
from the deal without paying Huntsman at least $325 million in liquidated
damages.
G. April 22, 2008: Huntsman Reports Poor First Quarter Of 2008
Initially, Hexion and Apollo were extremely excited about the deal with
Huntsman. Apollo partner Jordan Zaken testified at trial that Apollo really wanted
the deal and that “the industrial logic was very strong.”6 Indeed, Hexion’s April
2007 presentation materials regarding the potential transaction with Huntsman
reflect that the Hexion/Huntsman combination would create the largest specialty
chemical company in the world.7 While Huntsman’s Pigments business had been
slowing since shortly after signing, Hexion and Apollo’s view of the deal did not
seem to change dramatically until after receipt of Huntsman’s disappointing first
quarter numbers on April 22, 2008. Following receipt of these numbers, Apollo
revised its deal model and concluded that the transaction would produce returns
much lower than expected.8 At this time, Apollo also questioned whether
9 The “potential opportunities” include decreasing capital expenditures, timing the antitrustdivestitures to coincide with the closing of the transaction, gaining access to cash “trapped”overseas, rolling debt instead of refinancing, improving local borrowing, and deferringpre-payments.10 Scenario 1 shows revolver availability at a low point of $238 million in 2010. Scenario 2shows $56 million in revolver availability in 2009 and $5 million in 2010, but Zaken’shandwritten notes suggest that there is $175 million in cash trapped overseas.
11
Huntsman had experienced an MAE as defined in the merger agreement.
H. Apollo’s May 9, 2008 Meeting With Counsel
On May 9, 2008, Apollo met with counsel to discuss, among other things,
whether an MAE had occurred. In preparation for the meeting, Apollo created
three models: Run Rate, Scenario 1, and Scenario 2. The Run Rate model simply
annualizes Huntsman’s poor first quarter results. Scenario 1 assumed that the full
$1 billion revolver was available at closing and an equity contribution of
$445 million by Apollo. Scenario 2 removed the equity commitment and assumed
a $100 million annual increase in the synergies estimate (from $250 million to
$350 million) and included some of the over $1 billion in potential opportunities
identified by Apollo to improve liquidity.9 Zaken testified that these models were
created because Apollo was looking for a way to close the transaction. However,
Zaken later stated that these models were prepared to help evaluate with counsel
whether an MAE had occurred. Before Apollo’s May 9, 2008 meeting with
counsel, there appears to have been no discussion of the potential insolvency of the
combined companies. The May 9 models, while showing unfavorable returns for
Apollo and tight liquidity, do not clearly show insolvency.10
11 DX 2256, at DUFF024355.
12
After its May 9, 2008 meeting with counsel, perhaps realizing that the MAE
argument was not strong, Apollo and its counsel began focusing on insolvency.
However, under the merger agreement, Hexion had no right to terminate the
agreement based on potential insolvency of the combined company or due to lack
of financing. Also, Hexion would be subject to full contract damages if it
“knowingly and intentionally” breached any of its covenants. Therefore, it appears
that after May 9, 2008, Apollo and its counsel began to follow a carefully designed
plan to obtain an insolvency opinion, publish that opinion (which it knew, or
reasonably should have known, would frustrate the financing), and claim Hexion
did not “knowingly and intentionally” breach its contractual obligations to close
(due to the impossibility of obtaining financing without a solvency certificate).
I. Duff & Phelps Is Hired To Support Apollo’s Insolvency Theory
Watchell, Lipton, Rosen & Katz, Apollo’s counsel, hired Duff & Phelps,
LLC to support potential litigation, and Duff & Phelps personnel knew they were
being hired for that purpose. The May 16, 2008 notes of Allen Pfeiffer of Duff &
Phelps read: “get out. (1) Notice that insufficient capital to close (2) [Apollo]
hiring D&P to support that notion.”11 On May 23, 2008, Duff & Phelps, Wachtell
Lipton, and Hexion signed an engagement letter which envisioned the formation of
two teams: (1) a litigation consulting team and (2) an opinion team. Pffeifer led
12 DX 2259 at DUFF036085.13 Trial Tr. vol. 3, 881.
13
the opinion team and Philip Wisler led the opinion team. While Wisler testified
that no one told him the objective of his assignment was to support a lawsuit, he
was involved in initial conversations with Wachtell Lipton as early as May 15,
2008 and knew that Duff & Phelps’s litigation consulting team was advising
Wachtell Lipton. In addition, the engagement letter stated that the opinion team
would only be engaged if “Hexion decides to go forward with a particular course
of action,” presumptively if Hexion decided to claim insolvency in the potential
litigation.12
J. Litigation Consulting Team Concludes Insolvency, and Opinion Team Begins Its “Independent” Analysis
After the litigation consulting team concluded that insolvency of the
combined companies was likely, Wisler’s opinion team began its work on June 2,
2008. Until then, Wachtell Lipton wanted to make “doubly sure” that Wisler’s
team was walled off from the consulting team, so as not to taint the objectivity of
the resulting formal opinion.13 However, Wisler participated in calls with Wachtell
Lipton to discuss the engagement, the same individual performed the modeling
work for both teams, and Wisler was unaware that he was supposed to be walled
off. Even assuming arguendo, that Wisler’s opinion team was completely walled
off, they still knew that their client had litigation on its mind and still based their
14 A company need only fail one test to be considered insolvent.15 The valuation for the intercompany transfer was supported by fairness opinions fromValuation Research Company (“VRC”) and Murray Devine. Apollo provided VRC and MurrayDevine with its most recent and reasonable model in February 2008, which approximated thevalue of the combined entity at $15.8 billion.
14
opinion on the same biased numbers as the consulting team. The opinion team was
formed on June 3. On June 6, Wisler presented Duff & Phelps’s qualifications for
the assignment to the Hexion board of directors and Duff & Phelps was retained
the same day. On June 15, Duff & Phelps sent a draft opinion to Wachtell Lipton
and, on June 18, Duff & Phelps presented its insolvency opinion to the Hexion
board.
K. The Duff & Phelps Insolvency Report
Duff & Phelps’s insolvency opinion showed that the combined company
would fail each of the three tests of insolvency: (1) the balance sheet test; (2) the
ability to pay debts test; and (3) the capital adequacy test.14 In its opinion, Duff &
Phelps claimed the combined entity was worth $11.35 billion, $4.25 billion less
than Apollo concluded when it valued the entity for purposes of an intercompany
transfer in March 2008.15 The Duff & Phelps report also showed a gap between the
sources and uses of funds at closing of $858 million.
L. The Duff & Phelps Insolvency Opinion Is Unreliable
Duff & Phelps’s June 18, 2008 insolvency opinion was produced with the
knowledge that the opinion would potentially be used in litigation, was based on
16 DX 2495.17 DX 2369. Hexion’s projections for Huntsman’s EBITDA on July 12, 2007 was $1,064.2 million for 2008, $1,153.4 million for 2009, $1,261.7 million for 2010 and $1,312.5 million for 2011. Valuation Research’s February 12, 2008 model report projectsHuntsman’s EBITDA will be $1.072 billion in 2008, $1.108 billion in 2009, $1.209 billion in2010 and $1.272 billion in 2011. DX 2257. Apollo’s May 9, 2008 report (Scenarios 1 and 2)projects Huntsman’s EBITDA will be $954 million in 2008, $994 million in 2009, $1.106 billionin 2010 and $1.188 billion in 2011. PX-917. Duff & Phelps’s June 18, 2008 report projectsHuntsman’s EBITDA will be $867 million in 2008, $831 million in 2009, $898 million in 2010and $984 million in 2011. DX 2535. Hexion’s July 30, 2008 projections for Huntsman are$817.3 million for 2008, $808.7 million for 2009, $870.4 million for 2010, $951.5 million for2011. PX 719.
15
skewed numbers provided by Apollo, and was produced without any consultation
with Huntsman management. These factors, taken together, render the Duff &
Phelps opinion unreliable.
1. Pessimistic EBITDA Estimates For Huntsman And Hexion
The May 23, 2008 model which Apollo sent to Duff & Phelps for use in its
solvency analysis assumes substantial decreases in the multi-year EBITDA
projections for both Hexion and Huntsman, as compared to previous models. The
2009 to 2013 EBITDA projections in the May 23 model represent a 20% decrease
from two of the May 9 scenarios and a 31% decrease from the projections that
Apollo gave the lending banks in 2007 (which projections were lower than
Huntsman management projections at the time). The May 9 EBITDA projections
were themselves 2.6% lower than the April 26 model.16 The April 26 model was a
further 4.4% lower than the February model shared with valuation firms for the
purposes of a transfer of the interest between Apollo funds.17 While 2008 has
18 See id.19 Hexion has reduced its own 2008 forecasted EBITDA from $736 million on May 9, 2008 to$656 million on May 23, 2008 to $646 million for Duff & Phelps’s June 18, 2008 report to $606 million for Duff & Phelps’s August 1, 2008 report. DX 2495, DX 2258, DX 2535, DX2365.
16
admittedly been a difficult year for Huntsman thus far, Hexion also substantially
decreased its EBITDA projections for Huntsman in 2009, 2010, and 2011.18
In addition, from May 9 to May 23, Hexion decreased its estimated for its
own 2008 EBITDA by $80 million and its estimated 2009-2013 EBITDA by
$65 million. Leading up to trial, Hexion further reduced its own EBITDA
estimates.19
2. Negative Assumptions Are Used To Create A Funding Gap
The May 23, 2008 model used by Duff & Phelps also reflects a series of
pessimistic assumptions about the amount of cash needed to close the transaction.
While not directly related to the issue of solvency, these assumptions did cause
Duff & Phelps to reach its conclusion about a so-called “funding gap” of
$858 million.
a. The Apollo Fee
Apollo’s May 23 model, which was sent to Duff & Phelps, includes a
$102 million Apollo advisory fee that was not included in earlier deal models or
discussed at the time of the merger agreement. Apollo and Hexion argue that
Apollo is entitled to assess such a fee, if it chooses, by contract, but provide no
20 DX 2535.21 The four alternatives were “(1) Commit to funding above the minimum finding levels, (2) Waive Huntsman credit funding balances, (3) Post a letter [of] credit to be drawn on if [thecombined company is] not able to meet the minimum funding requirements [in the future], (4) Give the PBGC a silent second or third lien on certain assets as collateral.” DX 2708.
17
explanation of why it must be paid at closing. In fact, Apollo’s materials for its
May 9 meeting with counsel, show deferral of the Apollo fee as a temporary
savings item that could be put off until after closing.
b. United States Pension Fund Liability At Closing
In the deal models leading up to May 2008, the parties did not expect any
liability at closing resulting from United States pension funding requirements, yet
the model relied on by Duff & Phelps in issuing its opinion contained $195 million
in liability at closing.20 As late as May 30, 2008, the parties’ main contact at the
Pension Benefit Guarantee Corporation (“PBGC”) suggested to Hexion’s treasurer,
George Knight, four alternatives that would alleviate concerns about the
transaction, none of which required funding at closing.21
Laura Rosenberg, Hexion and Apollo’s litigation expert, told Duff & Phelps
that she believed the PBGC would require full funding of the pension fund at
closing ($200 million) or initiate a lawsuit to terminate the plans and collect the
same amount. However, Rosenberg’s own report admits the “PBGC prefers not to
terminate pension plans” and “seeks to enter into consensual settlements negotiated
22 In addition, Rosenberg’s ultimate conclusion that $200 million would be required at closingitself appears to have been influenced by the suggestions from Watchell Lipton. WhileRosenberg’s first draft shows the total underfunding of Huntsman’s U.S. pension plans at $200 million (a number the parties agree on), it appears to be Wachtell Lipton that suggested, ina June 10 draft and in brackets, that the cash payment at closing will likely be $200 million.
18
with plan sponsors.”22 Hexion and Apollo provided no explanation at trial for the
difference between Rosenberg’s opinion and the discussions regarding non-cash
alternatives that Hexion’s treasurer had discussed with the PBGC on May 30.
Huntsman’s U.S. pension, expert John Spencer, former PBGC director of the
Department of Insurance Supervision and Compliance, convincingly testified that
he saw no reason to believe that the PBGC would require $200 million in funding
at closing and thought it likely that no up-front payment would be required.
Spencer stated, that even assuming insolvency of the combined company or
assuming the combined company was headed for bankruptcy, he did not think the
PBGC would initiate involuntary termination or use the threat of such action to
demand $200 million.
c. United Kingdom Pension Fund Liability At Closing
PricewaterhouseCoopers (“PwC”) stated that the maximum United Kingdom
pension liability it envisioned at closing was $45 million and the May 9 model
estimated expected liability of $30 million at closing. However, the model relied
upon by Duff & Phelps in issuing its opinion contained $195 million in U.K.
pension liability at closing. The U.K. pension liability number was influenced by
19
the expert report of Richard Jones of a United Kingdom consulting firm, Punter
Southall.
Originally, Hexion hired PwC to advise it regarding potential U.K. pension
liability. In early June 2008, Hexion switched advisors, from PwC to Punter
Southall. Hexion’s CFO, William Carter, testified the change was made due to a
perceived conflict because PwC also worked for Huntsman and the U.K. trustees.
But, as Carter admitted, this conflict was discussed from the beginning of the
transaction and was resolved on the basis that U.K. law allows a firm to represent a
company and the trustees as long as a Chinese Wall is put in place. It is reasonable
to infer that Hexion stopped using PwC because it wanted to maintain
confidentiality as it explored the possibility of obtaining an insolvency opinion and
because it wanted its own litigation expert with no other responsibilities in the
transaction.
Jones, like all of the Apollo experts, knew that he was being hired in
connection with potential litigation. In addition, Jones did not speak with PwC,
Huntsman management, or the trustees. As it did with Rosenberg, Wachtell Lipton
offered comments on Jones’s report. For example, Wachtell Lipton suggested
deleting Jones’s sentence “[t]he only way to know for certain what would be
acceptable to the Trustees and the Pension Regulator in a clearance application
would be to enter negotiations with the Trustees and make a formal clearance
23 PX 1121.24 PX 1121.
20
application to the Pensions Regulator (noting that the settlement agreement is not
always considered sufficient for clearance to be granted.)”23 Wachtell Lipton also
suggested deleting “limited” from the phrase “based on the limited information
provided” and suggested deleting “considerably” from “these numbers . . . could be
considerably refined if more data became available.”24
d. Timing Of And Amount Of Antitrust Divestitures
The Federal Trade Commission (the “FTC”) requires that the antitrust
divestitures planned in connection with this transaction be completed within ten
days of closing. Carter testified that the antitrust divestitures are not shown as a
source of funds on the Apollo deal model given to Duff & Phelps, but admitted
that the divestitures could close at the same time as the merger agreement.
Simultaneous closings of the transaction and the antitrust divestitures would, of
course, substantially reduce the funding gap—a fact overlooked by Duff & Phelps.
In addition, the amount of the proceeds from divestitures appears to have
been materially adversely affected by Hexion’s litigation strategy. On May 27,
2008, in response to a request for bids, Hexion received eight bids for the assets to
be divested in connection with obtaining antitrust approval. Three of the bids, each
from very large chemical companies, were over $350 million and two were over
25 Carter testified that Hexion offered to pay certain of the bidders’ due diligence costs if theywould stay involved, but did not explain what percentage of the costs would be reimbursed orthe other terms of the offer. Nor did he provide any written evidence of the offer.26 One such area in which Wisler recognized that he could have received more accurateinformation was in regards to contingent liabilities. However, Wisler claimed that the differencein numbers would have had a de minimis impact on his analysis.
21
$400 million. After the filing of the lawsuit on June 18, 2008, the highest bidders
dropped out and Hexion entered into negotiations with one of the bidders who
expressed interest at $160 million. Two of the three highest bidders expressly
cited the lawsuit as a reason for withdrawing. The sale of the assets was to be
conditioned on the closing of the merger and certain bidders expressed that they
did not want to expend the time and financial resources to pursue a deal that was
uncertain to close.25
3. Apollo Prevents Duff & Phelps From Speaking To Huntsman Management
Duff & Phelps listed the fact that it did not have direct access to Huntsman
management as a “qualification” or “limiting condition” to its insolvency opinion.
Wisler testified that, given the chance, he was unsure whether he would have
chosen to talk with Huntsman management. However, Wisler admitted that he
could have received more accurate information, in at least some areas, from talking
to Huntsman management.26 Hexion’s CFO tried to de-emphasize the importance
of Duff & Phelps meeting with Huntsman management by testifying that, due to
Huntsman’s repeated missed projections, he did not think it would be a fruitful
22
exercise. In contrast, the record shows that Apollo prevented Duff & Phelps from
access to Huntsman management because allowing such access might compromise
the objectives of the Hexion board. These “objectives” appear to include
terminating the merger agreement.
M. The June 18, 2008 Lawsuit
After obtaining the Duff & Phelps insolvency opinion, Hexion, without
notice to Huntsman, published that opinion as part of this lawsuit, very likely
prejudicing the lending banks, the pension boards, and the FTC. Malcolm Price, a
managing director at Credit Suisse, testified that, until the filing of the lawsuit, the
bank had not questioned the solvency of the combined company or whether an
MAE had occurred, although it had recorded large mark-to-market losses.
Following publication of the insolvency opinion, Credit Suisse began to study the
potential insolvency of the company. On September 5, Credit Suisse finished its
own insolvency analysis, largely based on the deal model used by Duff & Phelps,
and sharply reduced its expected losses on the financing. The Credit Suisse
analysis showed insolvency under all three tests, by an even greater margin than
the Duff & Phelps report. Currently, both lending banks have stated that they
would be willing to meet their obligations to provide financing if a customary and
reasonably satisfactory solvency certificate could be provided. At trial however,
Hexion’s CEO, Craig Morrison, agreed that publication of the Duff & Phelps
27 Trial Tr. vol. 1, 85, 93.
23
opinion and the filing of the lawsuit “effectively kill[ed] the financing” and “make
it virtually impossible for [the lending banks] to go forward with the financing.”27
Nonetheless, Hexion still made the deliberate decision not to consult with
Huntsman regarding the analysis prior to filing the lawsuit. Price admitted that it
would be premature to draw a definite conclusion about solvency before closing.
However, he also testified that he could not think of anything plausible that would
change his view on solvency in the very near future and admitted that it would be
financially advantageous to Credit Suisse if it did not have to honor its
commitment letter.
N. Merrill Lynch, Huntsman’s Financial Advisor, Analyzes The Situation
Patrick Ramsey, Merrill Lynch’s managing director on the
Hexion/Huntsman transaction, testified that from the beginning of the deal he
recognized that an MAE was a potential way out for the banks under the deal for
Hexion and absence of a reasonably satisfactory solvency certificate was a way out
of the commitment letter. Ramsey testified that in May of 2008 he believed that
Hexion and the lending banks may try to get out of the deal because the Huntsman
stock was trading at a meaningful discount to the deal price. Thus, Ramsey asked
a junior banker on his team to look into the solvency issue before Huntsman’s May
8, 2008 board meeting. The junior banker, who Ramsey testified had no
28 The May 8, 2008 board meeting was the last regularly scheduled meeting before the thenexpected closing date of July 4, 2008.29 PX 629. Ramsey’s statement was based on Huntsman management’s current estimate, at thetime, of $900 million in EBITDA for 2008.
24
experience in performing solvency analyses, reported that the combined company
looked insolvent. Ramsey testified that he was not impressed with the analysis,
noting that Merrill Lynch is not in the business of providing solvency opinions.
Ramsey did not advise the Huntsman board regarding solvency at the May 8, 2008
meeting.28 Ramsey testified that he requested the solvency analysis due to the
dramatic change in the credit markets over the course of the year and the fact that
many banks were trying to get out of similar commitments.
On June 26, 2008, eight days after the filing of this lawsuit, the Huntsman
board met again. At this meeting, Huntsman and Merrill Lynch had the Duff &
Phelps opinion letter but did not have the analysis behind it. Board minutes from
the June 26 meeting read: “Mr. Ramsey stated that while leverage was high and
liquidity was tight, he believed that a good case could be made that the combined
entity would be solvent, in direct contradiction to Hexion’s allegations.”29
Ramsey, stated that Merrill Lynch did not produce in-depth analysis on the MAE
issue for this meeting, but did produce a more detailed report for the July 1, 2008
meeting.
30 Merger Agreement § 7.1(b)(ii).
25
O. The July 1, 2008 Board Meeting: Huntsman Extends The Termination DateOf The Merger Agreement
At the July 1, 2008 meeting, the Huntsman board voted to extend the
termination date from July 4, 2008 to October 2, 2008. Hexion argues that, by
extending the termination date, Huntsman violated section 7.1(b)(ii) of the merger
agreement which requires that “the Board of Directors of [Huntsman] determine[]
in good faith (after consultation with [Hexion]), that there exists at such time an
objectively reasonable probability” that antitrust approval and consummation of
the transaction will occur within the subsequent 90-day period.30 Hexion argues
that Huntsman’s CFO, Kimo Esplin, brought a solvency analysis with him to the
board meeting that showed a clearly insolvent combined company. The model,
prepared by Merrill Lynch, showed a $53 million funding gap at closing and only
$10 million in liquidity at the end of the first quarter of 2009. Hexion points out
that Esplin did not inform the board of the funding gap and merely said the
liquidity would be tight without discussing the extent of that condition. Esplin,
however, explained that Huntsman received the analysis behind the Duff & Phelps
insolvency opinion in the “wee hours” of the morning of July 1 and that Huntsman
and Merrill Lynch had only six or seven hours to create the model he brought with
him to the board meeting. Huntsman asked Merrill Lynch to quickly build a model
31 Trial Tr. vol. 6, 1648.32 Trial Tr. vol. 6, 1648-49.
26
that looked like the Duff & Phelps model and Huntsman filled in the numbers with
what it thought were more reasonable estimates. Esplin testified that he did not
share the exact numbers with the Huntsman board because “we hadn’t spent a lot
of time with our own numbers. . . .we just called around and got our numbers from
our folks.”31 He further testified that, “we knew within those numbers there were
lots of discretionary items that we could elect to delay, or not do at all, that would
increase liquidity. And so that’s why I told the board I had done the analysis and I
felt like it was probable that this combined business would be solvent, but we
needed to do some more work.”32
P. The Huntsman Projections
Huntsman’s EBITDA projections for 2008 have gone from $1.289 billion as
of June 2007 to $863 billion at the time of trial. Both Peter Huntsman, Huntsman’s
CEO, and Esplin testified in detail about the negative effect of increased oil prices,
increased natural gas prices, a slowdown in the housing market, capital
expenditures, uncollected insurance proceeds, and the strengthening of foreign
currencies against the U.S. dollar has had on their business over the past year.
After reviewing the numbers behind the Duff & Phelps insolvency opinion,
Huntsman determined that Hexion’s revised projections for Huntsman’s EBITDA
33 Hulme testified in detail regarding Huntsman’s effort to restructure the Textile Effectsbusiness since its acquisition of the business from Ciba approximately two years ago. According
27
relied on by Duff & Phelps were unreasonably low. In response, Huntsman began
to update its own projections by having each of its divisions prepare new EBITDA
estimates for the rest of 2008 and for 2009 through 2013. On July 25, 2008,
Huntsman compiled the results from the divisions and produced its revised
EBITDA estimates. At trial, Huntsman’s division heads responsible for the
Polyurethanes, Pigments and Textile Effects businesses testified regarding the
rationale underlying their projections. Tony Hankins testified that the
Polyurethane forecasts were realistic for three main reasons: (1) the recent
installation of new technology in a Geismar, Louisiana MDI plant; (2) the China
MDI plant which is now operating at full capacity; and (3) multiple world-wide
growth projects Huntsman is in the process of employing. Simon Turner testified
that the projections for Pigments were reasonable because Pigments has already
met its third quarter 2008 forecasts, the projections assume conservative growth
assumptions such as 4% growth in Asia, and the projects assume lower than
historical growth margins. Paul Hulme testified that the Textile Effects projections
were achievable because the projections forecast revenue growth at about the rate
of world-wide GDP growth. Hulme further testified that much of the projected
EBITDA growth will come from cutting indirect costs and selling, general and
administrative expenses.33
to Hulme, Huntsman has already completed two phases of the restructuring process—“ColumbusI” and “Columbus II”—and expects annual savings of $54 million from these projects. Hulmeexpects “Columbus III” to add additional annual benefits by the end of 2009.34 Esplin explained that, as a rule of thumb, Huntsman’s direct costs go down $140 million forevery $10 decrease in barrel of crude oil and $24 million for every $1 decrease in MBTU ofnatural gas. Esplin also testified about $427 million in expenditures Huntsman has recentlymade modernizing five plants, from which he expects incremental EBITDA benefit in 2009.35 The three conflicted companies are Merrill Lynch, Credit Suisse, and Deutsche Bank.
28
Just as Apollo’s estimates for Huntsman’s July 25, 2008 projections for
EBITDA appear artificially depressed, Huntsman’s EBITDA projections appear
somewhat optimistic. Both sets of projections have been influenced by the
potential or the reality of litigation. Huntsman projects a 31% increase in EBITDA
from 2008 to 2009.34 Apollo points out that Huntsman’s 2009 EBITDA and 2010
EBITDA projections are 24% more optimistic and 48% more optimistic,
respectively, than the expectations of Wall Street analysts. However, the Duff &
Phelps report and Hexion’s projections of Huntsman EBITDA surely have affected
the expectations of the analysts. Moreover, Esplin testified that the three leading
analysts covering Huntsman are conflicted out of publishing research.35 Esplin
also testified that he generally talked to every analyst covering Huntsman a couple
times a quarter to update them on the business, but that the analysts are no longer
interested in the fundamentals of the business, just the transaction. Esplin said he
has not talked to an analyst in nine months and therefore believes the Wall Street
estimates are not informed.
36 Trial Tr. vol. 6, 1657.37 Resnick testified at trial that the public company analysis generally leads to a lower result thanthe other tests because the public trading multiples do not account for a control premium. Nonetheless, Resnick followed Duff & Phelps’s weighting of the three tests in his analysis.38 Duff & Phelps looked at the latest 12 months, projected 2008 and projected 2009 EBITDA.
29
Q. Huntsman’s Solvency Analysis
Huntsman hired David Resnick, an expert on valuation and solvency, to
review the Duff & Phelps report for errors. Resnick is the head of global
restructuring and the co-head of investment banking in North America for
Rothschild, Inc. Duff & Phelps in its June 18 report found a funding deficit of
$858 million. Resnick’s report finds a surplus of $124 million. The majority of
the difference is made up of U.S. and U.K. pension liability, costs related to
refinancing the Huntsman debt, the Apollo fee, and timing of divestiture proceeds.
In arriving at his numbers, Resnick and his team used Duff & Phelps’s work
as a template and “adjusted it for what [they] saw as errors or inconsistencies.”36
Duff & Phelps’s enterprise value calculation was approximately $11.35 billion and
Resnick’s enterprise value calculation was approximately $15.42 billion. Duff &
Phelps reached its total enterprise value number by weighting the results of its
discounted cash flow analysis 50% and the average of its public company analysis
and transaction analysis 50%.37 Resnick took issue with Duff & Phelps’s public
company analysis because it looked at trading multiples of comparable companies
during a trough period for chemical companies.38 In contrast, Resnick looked at
39 Resnick added Dow’s acquisition of Rohm & Haas at 12.4 times EBITDA to the comparabletransaction pool. The three-year precedent transaction median was 10 times EBITDA. Resnicknotes that Apollo identified Rohm & Haas as the best comparable for a combined Huntsman andHexion. Hexion argued that Rohm & Haas’s margins are significantly higher than eitherHuntsman’s or Hexion’s. 40 The Duff & Phelps discounted cash flow analysis yielded an enterprise value of approximately$11.7 billion, with the difference being accounted for due to variations in EBITDA projections,the weighted average cost of capital, and the discount rate used. Resnick used Huntsmanmanagement’s July 25, 2008 projections.41 The difference between Duff & Phelps’s two tests is $700 million. The DCF analysis yieldsan $11.7 billion enterprise value and the public company/transaction analysis yields an $11 billion enterprise value.
30
those same companies over the past five years, which produced a multiple of 8.9
times EBITDA, as compared to a little over 7 times EBITDA in the Duff & Phelps
analysis. Resnick also criticized Duff & Phelps’s transaction analysis and its use
of a number of commodity chemical companies, which traditionally sell for much
lower multiples than specialty chemical companies like Huntsman.39 Hexion took
issue with Resnick’s discounted cash flow (“DCF”) analysis which led to an
enterprise value of $18.4 billion.40 Hexion pointed out the over $6 billion gap
between Resnick’s DCF analysis and his own public company/transaction analysis,
which yielded an enterprise value of $12.37 billion.41
On the balance sheet test, the Duff & Phelps report from June 18 shows
negative net asset value of $1.9 billion and Resnick’s report shows a positive net
asset value of $3.7 billion. The primary differences between the two numbers are
the calculation of total enterprise value, discussed above, and the differences in
synergies. Huntsman’s synergy estimates appear somewhat suspect. Huntsman
42 PX 180, at 2 (emphasis added).43 JX 1.
31
argues that Hexion underestimates synergies at $250 million and points to a
Hexion presentation that states $450 to $600 million in synergies “could be
achieved.”42 Resnick uses annual synergies in his analysis that reach $423 million
by 2013. While Huntsman points to some evidence that $250 million in synergies
was meant as a floor, the court notes that the $250 million number was widely used
before litigation became likely and that Hexion gave the $250 million number to
the lending banks in 2007.
Resnick also concluded that the combined company would pass the ability to
pay debts and capital adequacy tests. He notes that, under his analysis, there would
be $584 million in available revolver at closing, which, coupled with the
$416 million in cash, would result in the availability of the full $1 billion revolver
at closing.
R. Antitrust Approval
Section 5.4 of the merger agreement requires Hexion to “take any and all
action necessary” to obtain antitrust approval for the transaction, and prohibits
Hexion from taking “any action with the intent to or that could reasonably be
expected to hinder or delay the obtaining of” such approval.43 Hexion made its
initial Hart-Scott-Rodino filing with the FTC in August 2007 and received a
44 Trial Tr. vol. 6, 1833-34.
32
second request from the FTC in October 2007. On January 25, 2008, Hexion and
Huntsman entered into a timing agreement whereby they agreed to give the FTC
no fewer than 60-days notice before closing the transaction and that they would not
give such notice before March 3, 2008. The parties could, however, certify
compliance with the second request prior to March 3, 2008. Huntsman certified
compliance with the FTC’s second request on February 7, 2008.
In April 2008, Hexion proposed an agreement to the FTC, which included
divesting certain assets. The FTC told Hexion to find a buyer of the assets for FTC
approval and commented positively on the suggested settlement. As already
discussed above, Hexion received bids on those assets on May 27, 2008. However,
that marketing process was disrupted by the filing of this lawsuit.
On August 1, 2008, Huntsman, through counsel, requested in writing that
Hexion provide the FTC with notice, pursuant to the timing agreement, of the
parties’ intention to close the transaction in 60 days. Hexion refused, stating that
giving the FTC a deadline would only be giving them a deadline to sue to block the
transaction.44 The timing agreement permitted closing without giving the 60-day
notice only if the parties reached a negotiated settlement with the FTC.
On September 5, 2008, Jonathan Rich, an antitrust partner at Morgan, Lewis
& Bockius, who represents Hexion, sent a letter to the FTC which he testified
45 The letter reads: “[I]f the Commission does not accept a consent order for public commentprior to October 2, the agreement will be terminable by either party. Huntsman could thenterminate and seek to collect [] $325 million.” The letter continues: “We have come so close toreaching a final resolution that it would be most unfortunate if this transaction were to collapsebecause we have been unable to complete the antitrust process in time.” DX 3062.46 After the last day of trial, Hexion informed the court that it obtained signed agreements for thedivestitures.
33
explains the importance of reaching a settlement by October 2, 2008. But Rich’s
letter only makes reference to the possibility of Hexion losing the $325 million
break-up fee and does not mention the massive losses Huntsman could incur if the
transaction was not approved by October 2.45 As of September 16, 2008, the last
day of trial and only 16 days before the termination date of the merger agreement,
Hexion has negotiated a consent letter with the FTC staff, has a buyer for the assets
to be divested, and has negotiated purchase agreements. However, Rich testified
that Hexion has still not certified compliance with the FTC’s second request, does
not have signed agreements with the proposed buyer of the assets to be divested,
and does not have approval from the FTC staff or the Bureau of Competition.46
Nonetheless, Rich testified that he was confident that Hexion would receive
antitrust approval by October 2, 2008.
S. Alternative Financing
“If any portion of the Financing becomes unavailable,” section 5.12(c) of the
merger agreement requires Hexion to “use its reasonable best efforts to arrange to
obtain alternative financing from alternative sources in an amount sufficient to
47 Trial Tr. vol. 3, 700.
34
consummate the Transactions . . . on terms and conditions . . . no less favorable to
[Hexion] than those included in the Commitment Letter.” On July 15, 2008,
Hexion hired Gleacher Partners to find alternative financing, but narrowly limited
the scope of its assignment to financing that would completely replace the
financing on the same or better terms. Morrison admitted that no attempt to find
additional debt or equity financing had been made by Hexion or Gleacher. There
is no question that the substantial deterioration of the credit markets has made it
impossible to find replacement debt financing that is not materially less favorable
to Hexion than the financing contemplated in the commitment letter.
T. Offers By Certain Huntsman Shareholders
1. Contingent Value Rights And Equity Offers
On August 28, 2008, a group of Huntsman shareholders wrote a letter to
Hexion and Apollo offering to finance at least $500 million of the merger
consideration with Contingent Value Rights (“CVRs”). The offer was conditioned
on the closing of the merger and the receipt of commitments of $500 million.
Ramsey testified that the “CVRs had no coupon attached. They were deeply
subordinated. So I would most certainly consider them equity.”47 Hexion rejected
the CVR offer within two hours of its issuance. In the press release rejecting the
48 DX 2384.
35
CVR offer, Morrison stated “[w]e are not seeking to renegotiate this transaction.
We are seeking to terminate it.”48
2. Backstop Proposal
On the first day of trial, Huntsman issued an 8-K that attached a letter from
Jon Huntsman and certain other Huntsman shareholders committing $416,460,102
in cash towards the balance sheet of the combined company on closing of the
transaction (the “Backstop Proposal”). Ramsey testified that the Backstop
Proposal is essentially free money. On September 11, 2008, Hexion conditionally
consented to Huntsman entering into the Backstop Proposal, noting that it did not
think the proposal would fix the funding gap or solvency issues.
U. American Appraisal
In a letter attached to its September 12, 2008 8-K, Huntsman informed
Hexion that “[l]ast night, American Appraisal informed us that, based on its review
of relevant data to date, if our Company engages them under a standard
engagement agreement for solvency opinion services, and assuming no material
change between now and the effective date of its opinion, American Appraisal
would issue a written opinion stating that a combined Huntsman/Hexion entity is
solvent” and that “Huntsman expects to engage American Appraisal to deliver such
49 Trial Tr. vol. 6, 1563-64; DX 3054; Huntsman Corp.,Current Report (Form 8K) (September12, 2008), Ex. 99.1.
36
an opinion at the appropriate time.”49 On September 26, 2008, Huntsman issued an
8-K attaching a signed engagement letter with American Appraisal.
II.
Hexion argues that its obligation to close is excused as a result of a
Company Material Adverse Effect in the business of Huntsman. For the reasons
detailed below, Hexion’s argument fails.
A. The “Chemical Industry” Carve-Outs are Inapplicable
Section 6.2(e) of the merger agreement states that Hexion’s obligation to
close is conditioned on the absence of “any event, change, effect or development
that has had or is reasonably expected to have, individually or in the aggregate,” an
MAE. MAE is defined in section 3.1(a)(ii) as:
any occurrence, condition, change, event or effect that is materiallyadverse to the financial condition, business, or results of operations ofthe Company and its Subsidiaries, taken as a whole; provided,however, that in no event shall any of the following constitute aCompany Material Adverse Effect: (A) any occurrence, condition,change, event or effect resulting from or relating to changes in generaleconomic or financial market conditions, except in the event, and onlyto the extent, that such occurrence, condition, change, event or effecthas had a disproportionate effect on the Company and its Subsidiaries,taken as a whole, as compared to other Persons engaged in thechemical industry; (B) any occurrence, condition, change, event oreffect that affects the chemical industry generally (including changesin commodity prices, general market prices and regulatory changesaffecting the chemical industry generally) except in the event, and
50 A number of other carve-outs follow in subsections 3.1(a)(ii)(C)-(G). For reasons that will beapparent, they need not be listed here.51 The wording of the carve-outs was the subject of significant negotiation between the parties. The original form of merger agreement delivered to Hexion by Huntsman called for acomparison to “other Persons engaged in the chemical industry in the same region and segmentsas the Company . . . .” PX 98, at 9. Apollo’s comments to the initial draft modified thedefinition to substantially its present form, which it remained in for the rest of the negotiation. PX 125, at 9.
37
only to the extent, that such occurrence, condition, change, event oreffect has had a disproportionate effect on the Company and itsSubsidiaries, taken as a whole, as compared to other Persons engagedin the chemical industry . . . .50
The parties disagree as to the proper reading of this definition. Hexion
argues that the relevant standard to apply in judging whether an MAE has occurred
is to compare Huntsman’s performance since the signing of the merger agreement
and its expected future performance to the rest of the chemical industry.
Huntsman, for its part, argues that in determining whether an MAE has occurred
the court need reach the issue of comparing Huntsman to its peers if and only if it
has first determined that there has been an “occurrence, condition, change, event or
effect that is materially adverse to the financial condition, business, or results of
operations of the Company and its Subsidiaries, taken as a whole . . . .”51
Huntsman here has the better argument. The plain meaning of the carve-outs
found in the proviso is to prevent certain occurrences which would otherwise be
MAE’s being found to be so. If a catastrophe were to befall the chemical industry
and cause a material adverse effect in Huntsman’s business, the carve-outs would
38
prevent this from qualifying as an MAE under the Agreement. But the converse is
not true–Huntsman’s performance being disproportionately worse than the
chemical industry in general does not, in itself, constitute an MAE. Thus, unless
the court concludes that the company has suffered an MAE as defined in the
language coming before the proviso, the court need not consider the application of
the chemical industry carve-outs.
Hexion bases its argument that Huntsman has suffered an MAE principally
on a comparison between Huntsman and other chemical industry firms. Hexion’s
expert witness, Telly Zachariades of The Valence Group, largely focused on this at
trial. Zachariades testified regarding a comparison of the performance of
Huntsman during the second half of 2007 and first half of 2008, relative to two sets
of benchmark companies which he chose as representative of the industry—the
Bloomberg World Chemical Index and the Chemical Week 75 Index. Zachariades
compared Huntsman to these two benchmarks in a variety of different areas, both
backward and forward-looking, and, in each, found Huntsman significantly worse
than the mean, and, in most, in the bottom decile. This potentially would be
compelling evidence if it was necessary to reach the carve-outs, although
Huntsman’s expert, Mark Zmijewski, managed to cast doubt on Zachariades’s
52 At trial Huntsman’s expert, Mark Zmijewski, testified that Huntsman’s deviations from themean in these categories were not statistically significant. Ultimately, whether rigorousstatistical significance is necessary to find disproportionate performance need not be decided inthis case. Moreover, Zmijewski points out that Zachariades’ inconsistencies in using Capital IQdata for comparable-company EBITDA and Huntsman 10-Q data for Huntsman’s EBITDA,because they are calculated differently, results in an unwarranted negative skew in Zachariades’ranking of Huntsman in his various metrics. 53 In re IBP, Inc. S’holders Litig., 789 A.2d 14, 67 (Del. Ch. 2001); see also James C. Freund,Anatomy of A Merger: Strategies and Techniques for Negotiating Corporate Acquisitions 246(Law Journals Seminars-Press 1975) (“[W]hatever the concept of materiality may mean, at thevery least it is always relative to the situation.”). Although IBP technically is with respect to amaterial adverse effect clause in a contract governed by New York law rather than Delawarelaw, the logic of IBP is no less applicable. See Frontier Oil v. Holly Corp., 2005 WL 1039027,at *34 (Del. Ch.).54 IBP, 789 A.2d at 67.
39
analysis.52 However, because, as discussed below, Huntsman has not suffered an
MAE, the court need not reach the question of whether Huntsman’s performance
has been disproportionately worse than the chemical industry taken as a whole.
B. Huntsman Has Not Suffered An MAE
For the purpose of determining whether an MAE has occurred, changes in
corporate fortune must be examined in the context in which the parties were
transacting.53 In the absence of evidence to the contrary, a corporate acquirer may
be assumed to be purchasing the target as part of a long-term strategy. The
important consideration therefore is whether there has been an adverse change in
the target’s business that is consequential to the company’s long-term earnings
power over a commercially reasonable period, which one would expect to be
measured in years rather than months.54 A buyer faces a heavy burden when it
attempts to invoke a material adverse effect clause in order to avoid its obligation
55 Id. at 68 (“Practical reasons lead me to conclude that a New York court would incline towardthe view that a buyer ought to have to make a strong showing to invoke a Material AdverseEffect exception to its obligation to close.”). 56 Id.57 Pl.’s Post-Trial Br. 38 n.35.
40
to close.55 Many commentators have noted that Delaware courts have never found
a material adverse effect to have occurred in the context of a merger agreement.
This is not a coincidence. The ubiquitous material adverse effect clause should be
seen as providing a “backstop protecting the acquirer from the occurrence of
unknown events that substantially threaten the overall earnings potential of the
target in a durationally-significant manner. A short-term hiccup in earnings should
not suffice; rather [an adverse change] should be material when viewed from the
longer-term perspective of a reasonable acquirer.”56 This, of course, is not to say
that evidence of a significant decline in earnings by the target corporation during
the period after signing but prior to the time appointed for closing is irrelevant.
Rather, it means that for such a decline to constitute a material adverse effect, poor
earnings results must be expected to persist significantly into the future.
Hexion protests being shouldered with the burden of proof here, urging the
court that Huntsman bears the burden of showing the absence of an MAE, because
that is a condition precedent to closing. In support of this proposition Hexion cites
no cases directly related to material adverse effect clauses. Instead, Hexion cites
two cases57 for the general proposition that “a party who seeks to recover upon a
58 Metro. Life. Ins. Co. v. Jacobs, 1 A.2d 603, 606 (Del. 1938).59 IBP, 789 A.2d at 65. Hexion’s entire argument on the subject is restricted to two sentences infootnote 35 of its post-trial brief. Given the extraordinary effect a difference in which partycarries the burden could have on the outcome of this litigation, the fact that it spends but twosentences attempting to distinguish the leading case in this jurisdiction on the subject of materialadverse effect clauses leaves the court suspicious that Hexion simply could not muster from thecase law any stronger argument on the subject.60 Of course, the easiest way that the parties could evidence their intent as to the burden of proofwould be to contract explicitly on the subject. The idea that it would be helpful for parties toallocate explicitly the burden of proof with respect to material adverse effect clauses is notnovel. See Frontier Oil, 2005 WL 1039027, at *34.61 See 13 WILLISTON ON CONTRACTS § 38:7 (4th ed.).
41
contract must prove such facts as are necessary to establish a compliance with
conditions precedent thereto cannot be denied.”58 This is undoubtedly true, so far
as it goes. Hexion argues that IBP, in placing the burden to prove a material
adverse effect on the buyer, is distinguishable because in IBP the material adverse
effect clause was drafted in the form of a representation and warranty that no
material adverse effect had occurred.59 But material adverse effect clauses are
strange animals, sui generis among their contract clause brethren. It is by no
means clear to this court that the form in which a material adverse effect clause is
drafted (i.e., as a representation, or warranty, or a condition to closing), absent
more specific evidence regarding the intention of the parties, should be dispositive
on the allocation of the burden of proof.60 Typically, conditions precedent are
easily ascertainable objective facts, generally that a party performed some
particular act or that some independent event has occurred.61 A material adverse
effect clause does not easily fit into such a mold, and it is not at all clear that it
62 See IBP, 789 A.2d at 68.63 Those Certain Underwriters at Lloyd’s, London v. Nat’l Installment Ins. Servs, Inc., 2007 WL4554453 (Del. Ch.) (quoting Rhone-Poulenc v. GAF Chem. Corp., 1993 Del. Ch. LEXIS 59, at*7 (Apr. 6, 1993)).64 Joint Pretrial Stipulation and Order at 9. This is the framing of the question under theDefendant–Counterclaim Plaintiff’s heading. The Plaintiff–Counterclaim Defendant’s frame thesame question as “Whether under Section 6.2(e) of the Merger Agreement, Huntsman has, sinceexecution of the Merger Agreement, experienced events, changes, effects or developments thathave had or are reasonably expected to have, in the aggregate, a Company Material AdverseEffect on Huntsman such that if the conditions to the closing of the Merger were measured now,Hexion would have no obligation to effect the Merger and would bear no liability and noobligation to pay any termination or other fee to Huntsman as a result of the failure of theMerger to be consummated.” Id. at 7. Thus while Huntsman framed the question in terms of theburden being placed on Hexion, Hexion framed the question in the pretrial order in burden-neutral terms.
42
ought to be treated the same for this purpose. Rather, for the same practical
reasons that the court in IBP cites62, it seems the preferable view, and the one the
court adopts, that absent clear language to the contrary, the burden of proof with
respect to a material adverse effect rests on the party seeking to excuse its
performance under the contract. This outcome is also in accord with this court’s
holding that in determining the allocation of the burden of proof in suits for
declaratory judgment, “the better view is that a plaintiff in a declaratory judgment
action should always have the burden of going forward.”63 This rule would also
place the burden of proof that an MAE has occurred on Hexion, as the initial
seeker of a declaratory judgment that an MAE has occurred. Furthermore, as the
parties jointly stipulate, the question is “[w]hether Hexion has established that a
‘Company Material Adverse Effect,’ as defined in the Merger Agreement, has
occurred.”64 This again places the burden to show the existence of an MAE
squarely on Hexion.
65 More precisely, most of the existing debt of the target company generally must be redeemed asa result of the Change of Control provisions of the credit agreements and trust indentures suchdebt is subject to. The source of the cash to redeem that debt is a matter of discretion for theacquirer.
43
The issue then becomes what benchmark to use in examining changes in the
results of business operations post-signing of the merger agreement—EBITDA or
earnings per share. In the context of a cash acquisition, the use of earnings per
share is problematic. Earnings per share is very much a function of the capital
structure of a company, reflecting the effects of leverage. An acquirer for cash is
replacing the capital structure of the target company with one of its own choosing.
While possible capital structures will be constrained by the nature of the acquired
business, where, as here, both the debt and equity of the target company must be
acquired,65 the capital structure of the target prior to the merger is largely
irrelevant. What matters is the results of operation of the business. Because
EBITDA is independent of capital structure, it is a better measure of the
operational results of the business. Changes in Huntsman’s fortunes will thus be
examined through the lens of changes in EBITDA. This is, in any event, the metric
the parties relied on most heavily in negotiating and modeling the transaction.
Hexion focuses its argument that Huntsman has suffered an MAE along
several lines: (1) disappointing results in Huntsman’s earnings performance over
the period from July 2007 through the present; (2) Huntsman’s increase in net debt
66 Huntsman’s codename for its sale process.
44
since signing, contrary to the expectations of the parties; and (3) underperformance
in Huntsman’s Textile Effects and Pigments lines of business.
1. Huntsman Has A Difficult Year After The Signing Of The MergerAgreement
There is no question that Huntsman’s results from the time of signing in July
2007 until the end of the first half of 2008 have been disappointing. Huntsman’s
first-half 2008 EBITDA was down 19.9% year-over-year from its first-half 2007
EBITDA. And its second-half 2007 EBITDA was 22% below the projections
Huntsman presented to bidders in June 2007 for the rest of the year.
Realizing, however, that these results, while disappointing, were not
compelling as a basis to claim an MAE, Hexion focused its arguments on
Huntsman’s repeated misses from its forecasts. In its “Project Nimbus”66 forecasts,
Huntsman management projected 2008 consolidated EBITDA of $1.289 billion.
As of August 1, 2008, Huntsman management projected EBITDA for 2008 was
$879 million, a 32% decrease from the forecast the year before. Hexion points to
these shortfalls from the 2007 projections and claims that Huntsman’s failure to
live up to its projections are key to the MAE analysis.
But this cannot be so. Section 5.11(b) of the merger agreement explicitly
disclaims any representation or warranty by Huntsman with respect to “any
67 Section 5.11(b) reads in its entirety: (b) Each of Parent and Merger Sub agrees that, except for the representations and
warranties made by the Company that are expressly set forth in Section 3.1 of this Agreement (asmodified by the Company Disclosure Letter or as disclosed in the SEC Documents) and in anycertificate provided pursuant to Section 6.2(c), neither the Company nor any other Person hasmade and shall not be deemed to have made any representation or warranty of any kind. Without limiting the generality of the foregoing, each of Parent and Merger Sub agrees thatneither the Company, any holder of the Company’s securities nor any of their respectiveAffiliates or Representatives, makes or has made any representation or warranty to Parent,Merger Sub or any of their representatives or Affiliates with respect to:
(i) any projections, forecasts or other estimates, plans or budgets of future revenues,expenses or expenditures, future results of operations (or any component thereof), futurecash flows (or any component thereof) or future financial condition (or any componentthereof) of the Company or any of its Subsidiaries or the future business, operations oraffairs of the Company or any of its Subsidiaries heretofore or hereafter delivered to ormade available to Parent, Merger Sub or their respective representatives or Affiliates;(ii) any other information, statement or documents heretofore or hereafter delivered to ormade available to Parent, Merger Sub or their respective representatives or Affiliates,except to the extent and as expressly covered by a representation and warranty made bythe Company and contained in Section 3.1 of this Agreement.
68 This would actually end up looking from an economic perspective a lot like the ContingentValue Rights offered by Citadel, D.E. Shaw, and other hedge funds to help close the purported“funding gap.” See Huntsman Corp., Current Report (Form 8-K), Ex. 99.1 (August 29, 2008).
45
projections, forecasts or other estimates, plans or budgets of future revenues,
expenses or expenditures, future results of operations . . ., future cash flows . . . or
future financial condition . . . of [Huntsman] or any of its Subsidiaries . . .
heretofore or hereafter delivered to or made available to [Hexion or its affiliates]
. . . .”67 The parties specifically allocated the risk to Hexion that Huntsman’s
performance would not live up to management’s expectations at the time. If
Hexion wanted the short-term forecasts of Huntsman warranted by Huntsman, it
could have negotiated for that. It could have tried to negotiate a lower base price
and something akin to an earn-out,68 based not on Huntsman’s post-closing
69 See 11 WILLISTON ON CONTRACTS § 32:5 (4th ed.) (“An interpretation which gives effect to allprovisions of the contract is preferred to one which renders a portion of the writing superfluous,useless or inexplicable. A court will interpret a contract in a manner that gives reasonablemeaning to all of its provisions, if possible.”).70 It is worth noting that Hexion is not raising a claim of fraud in the inducement, or any similartort claim, against Huntsman. Rather, Hexion’s claim is firmly rooted in contract. To the extentthe contract deals with risk associated with the forecasts, that risk is implicitly excluded from thedefinition of Company Material Adverse Effect. This is natural given the role of a materialadverse effect clause as a backstop provision.
46
performance but on its performance between signing and closing. Creative
investment bankers and deal lawyers could have structured, at the agreement of the
parties, any number of potential terms to shift to Huntsman some or all of the risk
that Huntsman would fail to hit its forecast targets. But none of those things
happened. Instead, Hexion agreed that the contract contained no representation or
warranty with respect to Huntsman’s forecasts. To now allow the MAE analysis to
hinge on Huntsman’s failure to hit its forecast targets during the period leading up
to closing would eviscerate, if not render altogether void, the meaning of section
5.11(b). It is a maxim of contract law that, given ambiguity between potentially
conflicting terms, a contract should be read so as not to render any term
meaningless.69 Thus, the correct interpretation cannot be that section 6.2(e) voids
section 5.11(b), making it a condition precedent to Hexion’s obligation to
consummate the merger that Huntsman substantially meet its forecast targets.70
Rather, the correct analysis is that Huntsman’s failure to hit its forecasts cannot be
a predicate to the determination of an MAE in Huntsman’s business. Moreover, at
71 Merger Agreement § 3.1(a)(ii).72 Trial Tr. vol. 5, 1386-87. See 17 C.F.R. § 229.303 (2008).
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trial Jordan Zaken, one of the Apollo partners involved in negotiating the
Huntsman deal on behalf of Hexion, admitted on cross-examination that Hexion
and Apollo never fully believed Huntsman’s forecasts. Those forecasts, therefore,
cannot be the basis of a claim of an MAE, since they never formed part of the
expectations of the parties (in a strict contractual sense) to begin with.
Rather, as Huntsman’s expert Zmijewski testified at trial, the terms
“financial condition, business, or results of operations”71 are terms of art, to be
understood with reference to their meaning in Regulation S-K and Item 7, the
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations” section of the financial statements public companies are required to
file with the SEC.72 In this section, a company is required to disclose its financial
result for the period being reported, along with its pro forma financial results for
the same time period for each of the previous two years. Zmijewski testified at
trial that these results are analyzed by comparing the results in each period with the
results in the same period for the prior year (i.e., year-end 2007 results to year-end
2006 results, first-quarter 2005 results to first-quarter 2004 results, and so forth).
The proper benchmark then for analyzing these changes with respect to an MAE,
according to Zmijewski (and the analysis the court adopts here), is to examine each
73 In accord with the discussion above regarding forecasts, Zmijewski testified that forecasts arenever used as the benchmark in such financial statements.74 Indeed, Huntsman’s Q3 2006 EBITDA was down 26% from Q2 2006, and Q4 2006 was down21% from Q3. In 2005, a similar pattern appeared as well, with Q3 2005 down 12% from Q2,and Q4 2005 down 43% from Q3. Id. Thus, Hexion should have been well aware at signing thatthe second-half of 2007 was likely to be less lucrative for Huntsman than the first.75 This follows from the basic proposition of corporate finance that the value of a company isdetermined by the present value of its future cash flows. Moreover, this is mandated by thelanguage of the merger agreement in section 6.2(e): “There shall not have occurred after the dateof this Agreement any event, change, effect, or development that has had or is reasonably
expected to have, individually or in the aggregate, a Company Material Adverse Effect.”(emphasis added).
48
year and quarter and compare it to the prior year’s equivalent period.73 Through
this lens, it becomes clear that no MAE has occurred. Huntsman’s 2007 EBITDA
was only 3% below its 2006 EBITDA, and, according to Huntsman management
forecasts, 2008 EBITDA will only be 7% below 2007 EBITDA. Even using
Hexion’s much lower estimate of Huntsman’s 2008 EBITDA, Huntsman’s 2008
EBITDA would still be only 11% below its 2007 EBITDA. And although
Huntsman’s fourth quarter 2007 EBITDA was 19% below its third quarter 2007
results, which were in turn 3% below its second quarter 2007 results, Huntsman
has historically been down on a quarter-over-quarter basis in each of the third and
fourth quarters of the year.74 Moreover, comparing the trailing-twelve-months
EBITDA for second quarter 2007 to second quarter 2008, the 2008 result is only
down 6% from 2007.
Of course, the expected future performance of the target company is also
relevant to a material adverse effect analysis.75 Hexion, on the basis of its
76 Even assuming that Hexion’s projections are true, this is only a 12% decrease fromHuntsman’s 2007 EBITDA and a 15% decrease from Huntsman’s 2006 EBITDA. See DX 3022at Ex. 3.
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estimates of Huntsman’s future profitability, urges that Huntsman has or is
expected to suffer an MAE. Hexion estimates that Huntsman will earn only
$817 million in 2008,76 and that its earnings will contract further in 2009, to
$809 million.
Huntsman responds with its own projections, that it will generate
$878 million of EBITDA in 2008, and $1.12 billion of EBITDA in 2009. To
support its projections, Huntsman offered testimony at trial by Peter Huntsman, its
CEO, Kimo Esplin, its CFO, Tony Hankins, the President of its Polyurethanes
division, Paul Hulme, President of its Materials and Effects Division, and Simon
Turner, Senior Vice President of its Pigments division. Each of the division
managers described in detail how he expected to reach his target earnings for the
following year, and described both how macroeconomic effects such as sharp
increases in the prices of crude oil and natural gas, and the weakening of the dollar
relative to the euro, contributed to a reduction in Huntsman’s 2008 earnings and
how the recent reversal of the trend in several of those macroeconomic effects
could be expected to positively change future EBITDA results. While the court
recognizes that management’s expectations for a company’s business often skew
towards the overly optimistic, especially in the presence of litigation, the court
50
ultimately concludes that Hexion’s projections reflect an overly pessimistic view of
Huntsman’s future earnings.
The fact that Hexion offered little detail as to how it arrived at its projections
for Huntsman’s business also diminishes the weight its projections deserve.
Ultimately, the likely outcome for Huntsman’s 2009 EBITDA is somewhere in the
middle. This proposition is confirmed by current analyst estimates for Huntsman
2009 EBITDA, which average around $924 million. This would represent a mere
3.6% decrease in EBITDA from 2006 to 2009, and a result essentially flat from
2007 to 2009. The court also notes that in two of the four original deal models
Apollo produced in June of 2007 to justify its $28 per share offer, Huntsman’s
projected 2009 EBITDA was significantly below this estimate, at $833 million in
the “Hexion Management Flat Case,” and at a mere $364 million in its recession
case. The other two models (“Hexion Management Case” and “Hexion
Management Case with Interest Rates Run at Caps”) are essentially the same as
each other except with respect to the expected interest rates on the debt facilities.
Thus in only one of Hexion’s three views of future operating performance of
Huntsman at the time of signing did Huntsman perform better in 2009 than it is
presently expected to by analysts.
These results do not add up to an MAE, particularly in the face of the
macroeconomic challenges Huntsman has faced since the middle of 2007 as a
77 IBP, 789 A.2d at 68.78 See Huntsman Corp., Annual Report (Form 10-K), at 80 (February 22, 2008).
51
result of rapidly increased crude oil and natural gas prices and unfavorable foreign
exchange rate changes. Ultimately, the burden is on Hexion to demonstrate the
existence of an MAE in order to negate its obligation to close,77 and that is a
burden it cannot meet here.
2. Huntsman’s Net Debt Expands During The Same Period
Hexion urges that Huntsman’s results of operations cannot be viewed in
isolation, but should be examined in conjunction with Huntsman’s increase in net
debt. As of the end of June 2007, Huntsman forecast that its net debt at the end of
2008 would be $2.953 billion. At the time, its net debt stood at $4.116 billion. It
expected that this reduction in debt would be financed by the divestiture of three of
its divisions (which was accomplished by the end of 2007) and by its operating
cash flows.78 Things did not go according to plan. Driven largely by dramatic
increases in the prices of inputs and growth in accounts receivables, working
capital expanded during this time by $265 million, while foreign exchange effects
on the outstanding debt balances resulted in a dollar-denominated increase in the
notional value of Huntsman’s debt of an additional $178 million. All told, rather
than shrinking by a billion dollars, Huntsman’s net debt since signing has
expanded by over a quarter of a billion dollars.
79 Pl.’s Pretrial Br. 79.
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Hexion points to this debt expansion as further evidence (when combined
with the results of operations discussed above) of an MAE based on changes in the
financial condition of Huntsman. Huntsman, of course, points out that this
increase in net debt from signing until the present is only on the order of 5% or 6%
(depending upon which date one chooses to measure Huntsman’s debt, since
weekly changes in the total debt as a result of working capital fluctuations can be
as much as plus or minus $100 million), a far cry from an MAE based on financial
condition. Hexion responds that this view ignores the fact that “post-signing
Huntsman received $794 million in cash proceeds from divestitures that were to
have been used to repay debt. The assets were sold along with their revenue
generating capacity. An apples-to-apples comparison (adjusting to eliminate the
divestiture proceeds) would show an increase in net debt of 32%.”79 This argument
initially appears attractive, but examination of Apollo’s initial deal-model negates
any persuasive power it might have initially held. In all four of the cases which
Apollo modeled, Huntsman’s net debt at closing is assumed to be
$4.1 billion. All of Hexion’s assumptions about the value of the deal were
predicated on Huntsman net debt levels on that order–the projected decrease in
Huntsman’s net debt of a billion dollars was simply an added attraction. Hexion
cannot now claim that a 5% increase in net debt from its expectations in valuing
80 Hexion also offers a makeweight argument that Huntsman in its Project Nimbus due diligencematerials included updated projections for two other lines of business that had raised theirprojected earnings, but held back lowered projections in Pigments and Textile Effects. Hexionhas not however attempted to raise a claim of fraud in the inducement, which it obviously wouldbe unable to prove based on Zaken’s specific disclaimer of any reliance on Huntsman’sforecasts. While this behavior by Huntsman seems questionable (though in this case minorgiven the significance of those two businesses to Huntsman’s overall earnings), it is ultimatelyirrelevant. As discussed above, Huntsman in the merger agreement specifically disclaims anyrepresentations or warranties with respect to the forecasts provided to Hexion.81 A question not before this court and which the court takes no position on.
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the deal, even combined with the reduced earnings, should excuse it from its
obligation to perform on the merger agreement.
3. Challenging Times At Textile Effects And Pigments
Both in its pretrial brief and at trial, Hexion focused most of its attention on
two Huntsman divisions which have been particularly troubled since the signing of
the merger agreement–Pigments and Textile Effects.80 These two divisions were
expected to compose only 25% of Huntsman’s adjusted EBITDA in 2008–14%
coming from Pigments, and 11% coming from Textile Effects. Little space need
be spent on this argument as it falls under its own weight.
First, as already discussed, under the terms of the merger agreement, an
MAE is to be determined based on an examination of Huntsman taken as a whole.
A close examination of two divisions anticipated to generate at most a fourth of
Huntsman’s EBITDA is therefore only tangentially related to the issue. Although
the results in each of these two divisions, if standing alone, might be materially
impaired,81 as already illustrated above, Huntsman as a whole is not materially
82 Hulme’s experience at Huntsman includes the successful restructuring of the advancedmaterials, performance products, and polyurethanes businesses, the latter of which nowcontributes over 50% of Huntsman’s earnings.
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impaired by their results. If it is unconvincing to say Huntsman’s business as a
whole has been materially changed for the worse, it is even more unconvincing to
claim that 75% of Huntsman’s business is fine, but that troubles in the other 25%
materially changes the business as a whole.
Additionally, there is reason to believe that much of Huntsman’s troubles in
each of these divisions are short-term in nature. Paul Hulme,82 the President of
Huntsman’s Advanced Materials and Textile Effects business, testified at trial
regarding the headwinds Textile Effects has faced over the last year. Huntsman
first acquired the Textile Effects business from CIBA in June 2006, just over two
years ago, for $158 million. At that time, Textile Effects was burdened with an
inflated cost structure, which Hulme set about to change as part of Huntsman’s
Project Columbus (which is still ongoing). Included in this restructuring is the
closing of certain plants in Europe and the construction and expansion of
Huntsman’s Textile Effects presence in Asia, allowing Huntsman to follow the
shift in the textile manufacturing market there and minimize its manufacturing
costs and foreign exchange rate change exposures. Moreover, the Textile Effects
business faced a so-called “perfect storm” of macroeconomic challenges in the
first-half of 2008: its costs for inputs were inflated by the dramatic weakening of
55
the dollar against the euro, and the strengthening of the Swiss franc, Indian rupee,
and Chinese ren minh bi. Additionally, petroleum derivatives form a large portion
of the inputs to the Textile Effects manufacturing processes, and the dramatic
increase in the price of crude oil over the same period caused input costs to balloon
further. Notably, most of these macroeconomic changes have been reversing over
the period since the end of the second quarter of 2008. In addition, Huntsman has
been able to develop some traction in passing price increases into the market since
July 2008.
As for Pigments, titanium dioxide is a notoriously cyclical business, which
Apollo well knew at the time of bidding. During an initial presentation meeting
with the management of Huntsman, Josh Harris of Apollo expressed to Peter
Huntsman that Apollo knew as much about the titanium dioxide business as
Huntsman did. Apollo had over the year prior to negotiating the Huntsman deal
been in negotiations with Kerr McGee, one of Huntsman’s competitors in the
titanium dioxide business, to acquire Kerr McGee’s pigments business. Apollo
was therefore well familiar with the cyclicality that business is known to face.
Hexion focuses its argument on Huntsman’s use predominantly of the sulfate
process, while the majority of its competitors use the chlorine process for
manufacturing titanium dioxide. As a result of a recent run-up in the price of
sulfuric acid, a key input to the sulfate process, Huntsman has thus faced increased
83 See Merger Agreement §§ 7.3(d), 7.3(f), & 7.2(b).
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input costs that its competitors have not shared. Nevertheless, Tronox, one of
Huntsman’s major competitors in the pigments business and a user of the chlorine
process, is itself facing financial distress, partly as a result of its own cost
increases, illustrating that the present pain in the pigments business is not restricted
to those manufacturers using the sulfate process.
III.
Both parties seek declaratory judgment on the subject of knowing and
intentional breach. Hexion seeks a declaratory judgment that no “knowing and
intentional breach” of the merger agreement has occurred, and therefore its liability
for any breach of the merger agreement is capped at $325 million.83 Huntsman
seeks the obverse —a declaratory judgment that Hexion has engaged in a
“knowing and intentional breach” of the merger agreement, and therefore it is
entitled to full contract damages, not capped or liquidated by the $325 million
figure in section 7.3(d) of the merger agreement. For the reasons detailed below,
the court concludes that Hexion has engaged in a knowing and intentional breach,
and that the liquidated damages clause of section 7.3(d) is therefore inapplicable.
The court first turns to the meaning of “knowing and intentional breach” as
it is used in the merger agreement. “Knowing and intentional,” a phrase which
echoes with notes of criminal and tort law, is not normally associated with contract
84 Pl.’s Pretrial Br. 68.85 Id. at 69.86 Id. (citing MODEL PENAL CODE §§ 1.13(12), 202(a)).
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law. In fact, the term does not appear at all in either WILLISTON ON CONTRACTS or
the RESTATEMENT OF THE LAW OF CONTRACTS. Hexion argues in its pretrial brief
that a “knowing” breach “requires that Hexion not merely know of its actions, but
have actual knowledge that such actions breach the covenant,”84 and that
negligence or a mistake of law or fact will not suffice to establish a knowing
breach.85 Moreover, it argues, for such breach to also be “intentional,” Hexion
must have “acted ‘purposely’ with the ‘conscious object’ of breaching.”86
Hexion commits the same fundamental error in its analysis of both terms.
Hexion interprets the terms “knowing” and “intentional” as modifying the
violation of the legal duty supposed, rather than modifying the act which gives rise
to the violation. This is simply wrong. Momentarily drawing the analogy to
criminal law which Hexion invites makes this immediately clear: it is the rare
crime indeed in which knowledge of the criminality of the act is itself an element
of the crime. If one man intentionally kills another, it is no defense to a charge of
murder to claim that the killer was unaware that killing is unlawful. Similarly, if a
man takes another’s umbrella from the coat check room, it may be a defense to say
he mistakenly believed the umbrella to be his own (a mistake of fact). It is no
defense to say he had not realized that stealing was illegal, nor is it a defense that it
87 A mistake of law is an excuse only if the mistake negates one of the elements of the offense. For example, if a law made it a felony to fail to report a crime, it would be a defense to suchcharge that the defendant was unaware the act he had witnessed was criminal. But it would notbe a defense that he was unaware of his obligation to report crimes.88 For the proposition that a “knowing” breach requires that Hexion have actual knowledge thatits actions constitute a breach, Hexion cites several cases. According to Hexion, the court in Inre Doughty found that the “lawyer did not ‘knowingly’ disobey a court rule” because theevidence did not support an inference that the lawyer “actually knew of the bona fide officerequirement and knowingly practiced law in Delaware in violation of the requirement.” Pl.’sPretrial Br. 68 (quoting 832 A.2d 724, 734 (Del. 2003)). But Doughty involves a charge that alawyer violated DLRPC § 3.4(c), which states that a “lawyer shall not . . . (c) knowingly disobey
an obligation under the rules of a tribunal, except for an open refusal based on an assertion thatno valid obligation exists.” (emphasis added). Here, the key element of the charge is that thelawyer knew he was disobeying—if he was unaware of the obligation, he could not do so. Thisis exactly the unusual case discussed supra, note 87. Hexion’s other two cases on the subjectrelate to knowing participation in a board of director’s breach of fiduciary duties. Pl.’s PretrialBr. 68; see Malpiede v. Towson, 780 A.2d 1075, 1097 (Del. 2001); Associated Imports, Inc. v.
ASG Indus., Inc., 1984 WL 19833, at *12 (Del. Ch.). In this context the rule is that “[k]nowingparticipation in a board’s fiduciary breach requires the third party act with the knowledge thatthe conduct advocated or assisted constitutes such a breach.” Malpiede, 780 A.2d at 1097. Thereason for the divergence in this context from the normal rule is clear. In the absence of such arule, third parties would negotiate business dealings with a corporation at their peril. Becausewhether a particular act by a board constitutes a breach of fiduciary duty is highly contextspecific, such third-parties would have to undertake extensive due diligence in order to assurethemselves that the board had not breached a duty in authorizing the transaction. The rulerequiring actual knowledge that the transaction would constitute a breach removes this frictionand facilitates the commercial interaction of corporate entities. Such rule is unnecessary thoughfor those whom themselves are the subjects of the duty. A director need not know that his actionbreaches a fiduciary duty for liability for that breach to lie: gross negligence is sufficient forbreach of the duty of care, and no showing of knowledge is required. See, e.g., Smith v. Van
Gorkom, 488 A.2d 858, 873 (Del. 1985); Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984).
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was not his “purpose” to break the law, but simply to avoid getting wet. Contrary
to Hexion’s contention, mistake of law virtually never excuses a violation of law.87
Hexion cites a number of cases in support of its interpretation. However, once this
distinction between mistakes of fact and law is plain, it becomes equally plain that
the cases Hexion cites in support of its argument are inapposite.88 Indeed the
alternative would make “knowing and intentional breach” synonymous with willful
89 See 24 WILLISTON ON CONTRACTS § 64:1 (4th ed.):The fundamental principle that underlies the availability of contract damages is that ofcompensation. That is, the disappointed promisee is generally entitled to an award ofmoney damages in an amount reasonably calculated to make him or her whole andneither more nor less; any greater sum operates to punish the breaching promisor andresults in an unwarranted windfall to the promisee, while any lesser sum rewards thepromisor for his or her wrongful act in breaching the contract and fails to provide thepromisee with the benefit of the bargain he or she made.
90 See 24 WILLISTON ON CONTRACTS § 65:1 (4th ed.) (quoting RESTATEMENT (SECOND) OF
CONTRACTS § 356, comment (a).) (“As the drafters of the Restatement (Second) of Contractspoint out, and as the cases make clear, ‘[t]he central objective behind the system of contractremedies is compensatory, not punitive. Punishment of a promisor for having broken hispromise has no justification on either economic or other grounds and a term providing such apenalty is unenforceable on grounds of public policy.’”).91 Pl.’s Pretrial Br. 68.92 BLACK’S LAW DICTIONARY 888 (8th ed. 2004).
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and malicious breach, a concept ultimately having no place in an action sounding
in contract rather than tort. It is a fundamental proposition of contract law that
damages in contract are solely to give the non-breaching party the “benefit of the
bargain,” and not to punish the breaching party.89 It is for this very reason that
penalty clauses are unenforceable.90 Instead, the best definition of “knowing and
intentional breach” is the one suggested by Hexion’s citation to the entry for
“knowing” in Black’s Law Dictionary.91 Black’s lists “deliberate” as one of its
definitions for knowing.92 Thus a “knowing and intentional” breach is a deliberate
one—a breach that is a direct consequence of a deliberate act undertaken by the
breaching party, rather than one which results indirectly, or as a result of the
breaching party’s negligence or unforeseeable misadventure. In other words, a
“knowing and intentional” breach, as used in the merger agreement, is the taking of
93 PX 2 at D-2 ¶ 6. Paragraph 6 of Exhibit D (which exhibit consists of additional conditionsprecedent to the banks’ obligation to fund) reads in pertinent part:
The [lending banks] shall have received (i) customary and reasonably satisfactory legalopinions, corporate documents and certificates (including a certificate from the chieffinancial officer of [Hexion] or the chief financial officer of [Huntsman] or an opinionfrom a reputable valuation firm with respect to solvency (on a consolidated basis) of the[combined company] and its subsidiaries on the Closing Date after giving effect to theTransactions) (all such opinions, documents and certificates mutually agreed to be inform and substance customary for recent financings of this type with portfolio companiescontrolled by affiliates of or funds managed by [Apollo]) . . . .
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a deliberate act, which act constitutes in and of itself a breach of the merger
agreement, even if breaching was not the conscious object of the act. It is with this
definition in mind that Hexion’s actions will be judged.
A. Hexion’s Failure to Use Reasonable Best Efforts to Consummate theFinancing and Failure to Give Huntsman Notice of its Concerns
Hexion claims that it will be unable to consummate the merger because, if it
were to do so, the resulting company would, according to Hexion, be insolvent.
The commitment letter requires as a condition precedent to the banks’ obligation to
fund that the banks receive a solvency certificate or opinion indicating that the
combined entity would be solvent.93 Hexion argues that no qualified party will be
able to deliver such an opinion in good faith, and as such the banks will be neither
willing nor obligated to fund. Furthermore, Hexion claims, even if it were able to
convince the banks to fund under the commitment letter, there would still be
insufficient funds available to close the deal. Notably however, such was Apollo
and Hexion’s ardor for Huntsman in July 2007 that there is no “financing out” in
94 Although section 6.3(c) of the merger agreement makes delivery by Hexion to Huntsman of asolvency letter pursuant to section 5.13 of the merger agreement a condition precedent toHuntsman’s obligation to close, because this condition is for Huntsman’s protection Huntsmanmay choose to waive it. Hexion cannot, therefore, rely on the purported impossibility ofobtaining such a letter to avoid its own obligation to close.
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this deal—the conditions precedent to Hexion’s obligation to close do not contain
any requirement regarding the availability of the financing under the commitment
letter. Nor is there a “solvency out,” which would make Hexion’s obligation to
close contingent on the solvency of the combined entity.94 Nevertheless, as
Apollo’s desire for Huntsman cooled through the spring of 2008, Apollo and
Hexion attempted to use the purported insolvency of the combined entity as an
escape hatch to Hexion’s obligations under the merger agreement.
Section 5.12(a) of the merger agreement contains Hexion’s covenant to use
its reasonable best efforts to consummate the financing:
(a) [Hexion] shall use its reasonable best efforts to take, or cause tobe taken, all actions and to do, or cause to be done, all thingsnecessary, proper or advisable to arrange and consummate theFinancing on the terms and conditions described in the CommitmentLetter, including (i) using reasonable best efforts to (x) satisfy on atimely basis all terms, covenants and conditions set forth in theCommitment Letter; (y) enter into definitive agreements with respectthereto on the terms and conditions contemplated by the CommitmentLetter; and (z) consummate the Financing at or prior to Closing; and(ii) seeking to enforce its rights under the Commitment Letter. Parentwill furnish correct and complete copies of all such definitiveagreements to the Company promptly upon their execution.
Put more simply, to the extent that an act was both commercially reasonable and
advisable to enhance the likelihood of consummation of the financing, the onus
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was on Hexion to take that act. To the extent that Hexion deliberately chose not to
act, but instead pursued another path designed to avoid the consummation of the
financing, Hexion knowingly and intentionally breached this covenant.
Likewise, section 5.12(b) of the merger agreement provides in pertinent part:
(b) [Hexion] shall keep the Company informed with respect to allmaterial activity concerning the status of the Financing contemplatedby the Commitment Letter and shall give [Huntsman] prompt noticeof any material adverse change with respect to such Financing. Without limiting the foregoing, [Hexion] agrees to notify [Huntsman]promptly, and in any event within two Business Days, if at any time . . . (iii) for any reason [Hexion] no longer believes in good faith thatit will be able to obtain all or any portion of the Financingcontemplated by the Commitment Letter on the terms describedtherein.
This provision is equally simple. Hexion covenants that it will let Huntsman know
within two business days if it no longer believes in good faith it will be able to
draw upon the commitment letter financing.
Sometime in May 2008, Hexion apparently became concerned that the
combined entity, after giving effect to the merger agreement and the commitment
letter, would be insolvent. At that time a reasonable response to such concerns
might have been to approach Huntsman’s management to discuss the issue and
potential resolutions of it. This would be particularly productive to the extent that
such potential insolvency problems rested on the insufficiency of operating
liquidity, which could be addressed by a number of different “levers” available to
95 Both sides’ management testified that there are many “levers” a corporate manager can “pull”to address operating liquidity concerns.
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management.95 This is not what Hexion did. Instead Hexion, through Wachtell
Lipton, engaged Duff & Phelps ostensibly to provide them guidance as to whether
the combined entity would be in danger of being considered insolvent. At that
point, Hexion’s actions could not definitively be said to have been in breach of its
obligations under section 5.12(a).
By early June, Duff & Phelps reported back to Wachtell Lipton and Hexion
that, based on the information they had been provided, the combined company
appeared to fail all three of the customary insolvency tests (the failure of any one
of which is sufficient to render a company, for the purposes of delivering a
solvency opinion, insolvent). By this point Hexion, assuming arguendo it believed
in the projections it provided to Duff & Phelps in order to conduct the analysis,
would have had a justifiable good faith concern that it would not be able to provide
the required solvency certificate, and that the bank financing pursuant to the
commitment letter might be imperiled. Hexion was then clearly obligated to
approach Huntsman management to discuss the appropriate course to take to
mitigate these concerns. Moreover, Hexion’s obligations under the notification
covenant in section 5.12(b) of the merger agreement was now in play. Because
Hexion now had (again giving Hexion the benefit of the doubt) a good faith belief
96 Hexion also took a number of other actions that may ultimately prevent the feasibility ofconsummating the commitment letter financing because of the existence of a “funding gap.” Asdiscussed in the fact recitation earlier, three of the initial bidders (the three highest bidders) forHexion’s assets to be divested dropped out of the bidding after Hexion’s suit seeking toterminate the merger was commenced. Two of those three cited the lawsuit and the potentialthat the divestiture would therefore never close as their reason for disengaging. The average bidof the disengaging bidders was over $375 million. Following their disengagement, Hexionentered into negotiations with a bidder who had initially bid $160 million. Additionally, Hexioncould have (but did not) negotiate with the ultimate buyer to close the divestiture simultaneouslywith the Huntsman merger (as opposed to a few days later, as is actually the case). AssumingHexion had managed to entice even one of the three bidders who disengaged into paying theaverage of their initial bids, this could have resulted in substantially more cash available toHexion at closing, which combined with a simultaneous closing would thereby have closed thepurported funding gap by that amount. Hexion also may have caused the potential funding gapto expand by virtue of its tainting the pension regulatory negotiation process. Hexion’s initialadvice from PwC as to its potential liability to bolster the pension funds at closing was zeroliability in the U.S. and a maximum of $50 million in the U.K. Rather than entering intonegotiations with the PBGC and the U.K. pension regulators on that basis though, Hexioninstead (seemingly in an attempt to enhance their funding gap argument in an effort to avoid theconsummation of the merger) engaged new pension experts, ultimately increasing their pensionliabilities in their model to $200 million in the U.S. and $195 million in the U.K. Because of apotential rule change under U.K. pension regulations in March of this year, it is unclear whetherthe $195 million possibility is correct. The court was convinced however by the testimony ofHuntsman’s U.S. pension expert John Spencer that the PBGC was extremely unlikely to demanda $200 million payment on closing, and in fact that no-upfront payment would be required.
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that the combined entity would be insolvent, Hexion had an absolute obligation to
notify Huntsman of this concern within two days of coming to this conclusion, i.e.
within two days of receiving Duff & Phelps’s initial report.
But Hexion did nothing to approach Huntsman management, either to
discuss ways the solvency problems might be addressed, or even to put Huntsman
on notice of its concerns. This choice alone would be sufficient to find that Hexion
had knowingly and intentionally breached its covenants under the merger
agreement.96 Hexion in the days that followed would compound its breach further.
There is no question that both the PBGC and the U.K. pension regulators are by now aware ofHexion’s elevated expectations in this regard. To the extent that after negotiating with thePBGC and the U.K. pension regulators Hexion is obligated to pay this higher amount andthereby creates a larger funding gap, such gap could be found to be a direct result of Hexion’sobtaining these higher estimates and publishing them. Further, to the extent that any of theabove increases in the funding gap proximately results in a failure to consummate the financingand the merger, that failure will be a result of Hexion’s knowing and intentional breach in takingthe course of action that resulted in those increases.
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B. Hexion Affirmatively Acts To Scuttle The Financing
Section 5.12(b) of the merger agreement contains more than an affirmative
requirement that Hexion provide prompt notice to Huntsman if the financing is
imperiled. It also contains a negative covenant:
[Hexion] shall not, and shall not permit any of its Affiliates to,without the prior written consent of [Huntsman], take or fail to take
any action or enter into any transaction, including any merger,acquisition, joint venture, disposition, lease, contract or debt or equityfinancing, that could reasonably be expected to materially impair,
delay or prevent consummation of the Financing contemplated by the
Commitment Letter or any Alternate Financing contemplated by anyAlternate Financing. (emphasis added).
Hexion’s obligation under the covenant here is again quite simple: do nothing
without Huntsman’s written consent which might reasonably be expected to scuttle
or otherwise harm the likelihood or timing of the financing under the commitment
letter.
Apparently considering Duff & Phelps’s initial determination that the
combined entity would likely be insolvent insufficient for its purposes, on June 2,
2008, Hexion engaged a second Duff & Phelps team headed by Wisler, to provide
a formal solvency opinion, or, more to the point, a formal insolvency opinion.
97 A document apparently unprecedented in Duff & Phelps’s history of opinion practice except inits litigation practice. The normal practice in retaining a solvency expert to deliver a solvencyopinion is that if the team arrives at a result of insolvency, the client is simply informed thatDuff & Phelps will be unable to deliver a solvency opinion. The normal course is not to delivera formal opinion of insolvency to the client.
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The Duff & Phelps formal opinion team eventually delivered a formal
insolvency opinion97 to Hexion on June 18, 2008, which opinion was presented to
the Hexion board the same day. Concluding that the board could rely on the
opinion, Hexion’s did not contact Huntsman to discuss the issue. If Hexion had
contacted Huntsman at this point and requested a meeting between Hexion and
Huntsman management to discuss strategies to address the apparent insolvency
problem, Hexion would once again have been in compliance with its obligations
under the covenants in sections 5.12(a) and (b), and any knowing and intentional
breach resulting from its earlier failure to notify Huntsman would have been cured,
as no prejudice to Huntsman would have occurred by Hexion’s delay. But Hexion
chose an alternative tack. Upon adopting the findings of the Duff & Phelps
insolvency opinion on June 18, the Hexion board approved the filing of this
lawsuit, and the initial complaint was filed that day. In that complaint, Hexion
publicly raised its claim that the combined entity would be insolvent, thus placing
the commitment letter financing in serious peril. The next day, June 19, 2008,
Credit Suisse, the lead bank under the commitment letter, received a copy of the
Duff & Phelps insolvency opinion from Hexion, all but killing any possibility that
98 Trial Tr. vol. 1, 93-95.
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the banks would be willing to fund under the commitment letter. Morrison
testified on cross-examination that he was well aware that this was virtually certain
to be the consequence of delivering the insolvency opinion to the banks:
Q Okay. And it’s correct that you sent the banks both a copy of thislawsuit complaint and a copy of the Duff & Phelps insolvency opinion.Correct?A I believe so, yes.Q And you carefully considered the consequences of your doing that,did you not?A Yes.Q Okay. You knew that providing this to the banks would make itvirtually impossible for them to go forward with the financing?A Yes.
* * *Q Let’s look back at the contract. You mentioned the contract. Again,JX 1. Let’s look at 5.12(b). And let’s go down toward the -- yes. Herewe go. Right there. This is out of 5.12(b). Hexion, without the writtenconsent of Huntsman, cannot take any action that would be reasonablyexpected to materially impair, delay or prevent the financing contemplatedby the commitment letter. Correct?A Yes.Q And you are aware of this obligation. Correct?A Yes.Q All right. And you didn’t seek Huntsman’s consent to deliver theDuff & Phelps insolvency opinion to the banks?A No.Q Right. And even though you knew that delivering that insolvencyopinion would prevent consummation of the financing, you went ahead anddid it, anyway?A Yes.98
Given the court’s conclusion that a “knowing and intentional” breach must be the
deliberate commission of an act that constitutes a breach of a covenant in the
99 See 14 WILLISTON ON CONTRACTS § 43:5-6 (4th ed.):[M]odern courts, and the Restatement (Second) of Contracts, recognize that somethingmore than a mere default is ordinarily necessary to excuse the other party’s performance
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merger agreement, Morrison’s testimony makes clear that a knowing and
intentional breach by Hexion had occurred by June 19, 2008.
Hexion offers two arguments to justify its taking such dramatic and
irrevocable action. The first is that it wanted to secure its status as first filer in any
lawsuit arising out of the contract in order to ensure for itself a Delaware forum for
litigation. Although the merger agreement explicitly lays exclusive jurisdiction
over such suits in the Delaware Court of Chancery, Zaken testified at trial that
Apollo and Hexion were concerned that Huntsman might choose to bring suit in
Texas instead. But this is clearly no defense to a claim that Hexion knowingly and
intentionally breached its covenant not to act in any way which could be
reasonably expected to harm the likelihood of the consummation of the financing
without Huntsman’s express written consent. This proposed defense amounts to
nothing more than “we were afraid they might breach, so we breached first.” Even
if Huntsman had filed suit in Texas prior to Hexion’s breach of section 5.12(b), to
the extent that Huntsman’s filing of a suit in Texas might not constitute a material
breach of the merger agreement, Hexion’s performance under the contract still
would not be excused and it would have remained obligated to comply with the
terms of the covenants under the merger agreement.99 A fortiori, Hexion’s
in the typical situation, subscribing to the general rule that where the performance of oneparty is due before that of the other party, such as when the former party’s performancerequires a period of time, an uncured failure of performance by the former can suspend ordischarge the latter’s duty of performance only if the failure is material or substantial.Thus, if the prior breach of such a contract was slight or minor, as opposed to material orsubstantial, the nonbreaching party is not relieved of his or her duty of performance,although he or she may recover damages for the breach. In what is essentially a variationon the above rule, some courts have indicated that a breach of contract which is only“partial,” as opposed to “total,” will not relieve the other party from his or her obligationto perform . . . . For purposes of the general rule that one party’s uncured, materialfailure of performance under a contract calling for an exchange of performances willsuspend or discharge the other party’s duty to perform, whether a nonperformance issufficiently material is ordinarily an issue of fact. It is ultimately a question of degree,which, it has been said, should be decided based upon the inherent justice of the matter. Generally, such nonperformance will attain this level of materiality only when it goes tothe root, heart or essence of the contract or is of such a nature as to defeat the object ofthe parties in making the contract, or, as it has sometimes been said, when the covenantnot performed is of such importance that the contract would not have been made withoutit.
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obligation under the section 5.12(b) covenant cannot have been excused by
Hexion’s mere fear that Huntsman would breach the merger agreement by bringing
suit in Texas.
Hexion further argued in its pretrial brief that, had it spoken to Huntsman
with regards to its solvency concerns, it would have become obligated to notify the
banks of those concerns at that time as well. This is incorrect—Hexion’s
obligations to update the banks under the commitment letter are not predicated on
communication or the lack thereof between Hexion and Huntsman. Under
paragraph 4 of the commitment letter, Hexion’s obligation to the banks is to update
them with new information and projections to the extent they no longer accurately
100 Commitment Letter ¶ 4 provides in pertinent part: “You agree that if at any time prior to theclosing Date any of the representations in the preceding sentence would, to your knowledge, beincorrect in any material respect if the Information and Projections were being furnished, andsuch representations were being made, at such time, then you will promptly supplement theInformation and Projections to the extent of Information available to you so that suchrepresentations will be correct in all material respects under those circumstances.”
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represent present realities.100 If Hexion no longer had a good faith belief in the
information and projections it had given the banks, it would at that time be
obligated to update the banks of its new information or projections regardless of
whether it had communicated to Huntsman about this belief. As such,
communication with Huntsman could not have triggered any obligation on
Hexion’s part to update the banks.
Perhaps recognizing this flaw in its argument, Hexion seems to have
abandoned it in its post-trial brief. Instead, Hexion focuses on the conception that,
once in possession of the insolvency opinion, and the board of directors having
determined the opinion was reliable, Hexion was obligated to deliver the opinion to
the banks. However, Hexion had been feeding the banks Huntsman’s updated
forecasts as it received them. Its obligations to update the banks ended there. It
was under no obligation, even once it obtained the insolvency opinion, to deliver
the opinion to the banks, as the opinion did not constitute information of the type
delivered to the banks up to that point. Solvency is not an issue to be measured
prior to closing—rather, all that is required is that a suitable solvency letter can be
delivered in good faith in connection with closing.
101 Pl.’s Post-Trial Br. 72 (quoting Trial Tr. vol. 1, 124). Hexion also offers in support of thiscontention the statement by Malcolm Price of Credit Suisse that “Credit Suisse believed thatHexion was obligated to provide updated financial information pursuant to the CommitmentLetter.” Id. (citing Trial Tr. vol. 3, 726). But this simply speaks to Hexion’s obligation toprovide the banks with the updated projections, not with the insolvency opinion.102 Morrison’s complete colloquy on re-direct was:
Q. And you provided the Duff & Phelps book to the banks. Correct?A. Yes.Q. And there were projections in there?A. Yes.Q. Why did you do that?A. They represented our most current knowledge and projections, so we thought
they represented the current state as we understood it.Trial Tr. vol. 1, 123-24.
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Even the testimony that Hexion cites in its post-trial brief in support of the
contention that it was obligated to deliver the insolvency opinion to the banks is,
upon closer examination, not supportive of Hexion’s position. Hexion cites
Morrison as testifying that Hexion “was obligated to provide the Duff & Phelps
presentation to the banks because it ‘represented our most current knowledge and
projections.’”101 But Morrison actually testified that Hexion provided the Duff &
Phelps opinion to the banks because it contained updated projections.102 It is clear
that, to the extent Hexion believed that the updated projections contained in the
Duff & Phelps opinion represented a more accurate forecast for the future of the
combined business, Hexion was obligated to deliver those projections to the banks.
There is no reason why the projections could not be delivered in a format divorced
from the opinion—that is, in the same format they were given to Duff & Phelps.
The only reason to deliver the complete Duff & Phelps opinion was to ensure that
the banks would never be willing to fund under the commitment letter.
103 Merger Agreement § 5.12(a).104 Id. § 5.13(a).105 Pl.’s Post-Trial Br. 57.106 601 F.2d 609 (2d Cir. 1979) (Friendly, J).
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C. Hexion’s Counterargument
Hexion offers as a counterargument to the contention that it failed to use its
best efforts to consummate the financing103 and the merger104 the argument that “[a]
‘reasonable best efforts’ covenant does not prevent a company or its board from
seeking expert advice to rely upon in assessing its own future solvency, or, once it
has made an assessment that insolvency would ensue, from taking actions to avoid
insolvency.”105 The first contention (that it is permissible to seek expert advice) is
undoubtedly true, and the second (that it may take actions to avoid insolvency) is
on its face reasonable as well. But that Hexion’s board was permitted to take steps
to avoid insolvency upon closing the merger if it believed in good faith that would
ensue if it stayed on its present course is not the same thing as saying that Hexion
could therefore attempt to abandon the merger entirely before satisfying itself that
there were not commercially reasonable steps it could take to meet its obligations
under the merger agreement while still avoiding bankruptcy. Indeed, the case that
Hexion cites in support for its proposition, Bloor v. Falstaff Brewing Corp.,106
ultimately undercuts it. Hexion cites the case as stating that “a promise to use best
efforts does not strip the party of the ‘right to give reasonable consideration to its
107 Pl.’s Post-Trial Br. 57 (quoting Bloor, 601 F.2d at 614-15).108 Bloor, 601 F.2d at 614 (emphasis added).109 Id. at 614-15.
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own interests’ and does not require the party to ‘spend itself into bankruptcy.’”107
This is no doubt true, but it is also not all that Bloor says on the subject. The
sentence that Hexion quotes from Bloor in its entirety reads:
Although we agree that even this [the best efforts clause underconsideration] did not require [the defendant] to spend itself intobankruptcy to promote the sales of [plaintiff’s products], it did prevent
the application to them of [defendant’s controlling shareholder’s]
philosophy of emphasizing profit uber alles without fair consideration
of the effect on [plaintiff’s] volume.108
Bloor continues:
Plaintiff was not obliged to show just what steps [defendant] couldreasonably have taken to maintain a high volume for [plaintiff’s]products. It was sufficient to show that [defendant] simply didn’t careabout [plaintiff’s] volume and was content to allow this to plummet solong as that course was best for [plaintiff’s] overall profit picture, aninference which the judge permissibly drew. The burden then shiftedto [defendant] to prove there was nothing significant it could havedone to promote [plaintiff’s] sales that would not have beenfinancially disastrous.109
The situation in the instant case is analogous. Huntsman was not obligated
to show that Hexion had viable options to avoid insolvency while performing its
obligation to close, it merely needed to show (which it succeeded in doing) that
Hexion simply did not care whether its course of action was in Huntsman’s best
interests so long as that course of action was best for Hexion. At that point the
110 Triple-A Baseball Club Assoc. v. Northeastern Baseball, Inc., 832 F.2d 214, 222 (1st Cir.1987). Hexion cites this case for the proposition that a “best efforts clause” does not require thepromisor to make “every conceivable effort.” Pl.’s Post-Trial Br. 57.111 Pl.’s Post-Trial Br. 57 (quoting Triple-A Baseball Club Assoc., 832 F.2d 214). Hexion alsocites Martin v. Monumental Life Ins. Co., 240 F.3d 223, 234-35 (3d Cir. 2001) for the relatedproposition that “best efforts” is a form of “good faith and sound business judgment.” Pl.’s Post-Trial Br. 57.
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burden shifted to Hexion to show that there were no viable options it could
exercise to allow it to perform without disastrous financial consequences. Hexion
has not met this burden, nor has it attempted to. Rather, its contention from the
outset of this lawsuit has been that once it determined that the combined entity
would be insolvent, its obligations to Huntsman were at an end. The fact that a
conference with Huntsman management to discuss these concerns would have been
virtually costless only underscores the fact that Hexion made no attempts to seek
out its available options. Far from making “every conceivable effort,”110 Hexion
appears to have made no effort at all. Similarly, Hexion cites Triple-A Baseball
Club Association v. Northeastern Baseball, Inc. for the proposition that although
the “reasonable best efforts” standard is separate and distinct from good faith, the
court in Triple-A Baseball Club was “unable to find any case in which a court
found . . . that a party acted in good faith but did not use its best efforts.”111 This
court will not change that score. Rather, Hexion’s utter failure to make any
attempt to confer with Huntsman when Hexion first became concerned with the
potential issue of insolvency, both constitutes a failure to use reasonable best
efforts to consummate the merger and shows a lack of good faith.
112 Huntsman certified compliance with the FTC second request on February 7, 2008.
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D. Hexion Drags Its Feet On Receiving Antitrust Clearance
Section 5.4 of the merger agreement requires Hexion to “take any and all
action necessary” to obtain antitrust approval for the transaction, and prohibits
Hexion from taking “any action with the intent to or that could reasonably be
expected to hinder or delay the obtaining of” such approval. Unlike the reasonable
best efforts Hexion is obligated to make under other covenants in the merger
agreement, both parties have characterized this obligation as “come hell or high
water.”
In spite of this obligation, as of the time of trial (a mere three weeks before
the Termination Date) Hexion still had not received consent from the FTC to
consummate the merger. When asked about this, Morrison initially testified that
Hexion had certified compliance with the FTC’s second request under HSR.
Hexion later put on Jonathan Rich, Hexion’s antitrust counsel, to testify as to the
status of the antitrust negotiations with the FTC, in response to the court’s interest
in the subject. Rich, correcting Morrison, testified that Hexion had not responded
to certain interrogatories from the FTC as part of the second request, and therefore
had not certified compliance with the FTC’s second request, nor put itself in a
position to do so—although Rich noted that Hexion could be in a position to do so
on very short notice if it found it necessary to do so.112 Moreover, as of the time of
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trial, Hexion had not given the FTC its 60-day notice of its intent to close the
transaction, pursuant to the timing agreement, despite the impending October 2
termination date and Huntsman’s request on August 1 that Hexion do so. When
asked about this, Rich testified gamely that Hexion had not given notice because its
concern was that “by giving [the FTC] a deadline, the only deadline that we were
creating was a deadline in which [the FTC] would sue to block the transaction
. . . .” Yet, according to Rich, Hexion had come to an agreement in principal with
the FTC staff as to a divestiture plan to satisfy the FTC’s concerns in April, and by
August had a buyer for the assets to be divested. Notwithstanding this catalog of
footdragging and inaction, Rich testified at trial that he was confident that Hexion
would receive antitrust approval by the October 2 deadline.
The court ultimately finds Rich’s rationale for failing to “put the FTC on the
clock” at Huntsman’s request in August unconvincing. Rather than being a
diligent party making all necessary efforts to obtain antitrust clearance, come “hell
or high water,” the court was left with the impression that Hexion had, since May
or June, been dragging its feet on obtaining that clearance, pending the outcome of
its attempts to avoid the transaction, in contravention of its obligations under the
merger agreement.
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* * *
In the face of this overwhelming evidence, it is the court’s firm conclusion
that by June 19, 2008 Hexion had knowingly and intentionally breached its
covenants and obligations under the merger agreement. To the extent that it is at
some later time necessary for this court to determine damages in this action, any
damages which were proximately caused by that knowing and intentional breach
will be uncapped and determined on the basis of standard contract damages or any
special provision in the merger agreement. Because of the difficulty in separating
out causation of damages in such an action, the burden will be on Hexion to
demonstrate that any particular damage was not proximately caused by its knowing
and intentional breach. To the extent Hexion can make such a showing, those
damages which were not proximately caused by Hexion’s knowing and intentional
breach will be limited to the liquidated damages amount of $325 million, pursuant
to section 7.3(d) of the merger agreement.
IV.
Hexion strenuously argues, and urges the court to declare, that on a pro
forma basis (assuming the merger closes on the financing terms contemplated in
the commitment letter), the combined entity will be insolvent. In support of its
contention, Hexion offers the opinion it obtained from Duff & Phelps, based on
Hexion’s gloomy projections of Huntsman’s future performance. It also points to a
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rudimentary solvency analysis done by a Merrill Lynch analyst in May 2008.
Huntsman argues, in opposition, that solvency is not even an issue under the
merger agreement and, thus, is not a proper subject for declaratory relief at this
time. Huntsman also contends that the combined entity (1) will be solvent; (2) to
the extent that it is not solvent, that would come as a result of Hexion’s knowing
and intentional breach of contract, and (3) Hexion is, in any event, obligated to put
in whatever equity is necessary to close the transaction and make the combined
entity solvent. To support its argument regarding solvency, Huntsman relies on
Resnick’s expert valuation opinion, based on Huntsman’s revised July 2008
projections. In addition, at trial Huntsman introduced evidence suggesting that
American Appraisal Associates, Inc. has determined that, if engaged for that
purpose, it expected to be able to deliver a favorable solvency opinion. Even more
recently, Huntsman filed a Form 8-K stating that it has engaged American
Appraisal for this purpose, and asks the court to take judicial notice of that fact.
The court thus finds itself asked to referee a battle of the experts in which
there is no clear answer and no possibility of splitting the difference. For the
reasons briefly discussed below, the court determines not to reach the issue of
solvency at this time because that issue will not arise unless and until a solvency
letter or opinion is delivered to the lending banks and those banks then either fund
or refuse to fund the transaction.
113 The merger agreement makes only three substantive mentions of solvency: (1) In section3.2(k) of the agreement Hexion represents that, assuming Huntsman’s representations andwarranties remain true as and immediately following the consummation of the merger, thecombined entity will be solvent; (2) section 5.13(f) obligates Hexion to provide to Huntsman asolvency letter from an independent appraiser, opining that the combined entity, after givingeffect to the merger, will be solvent; and (3) section 6.3(c) makes Hexion’s delivery of the
solvency letter to Huntsman a condition precedent to Huntsman’s obligation to close.
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To begin with, Huntsman is correct that the solvency of the combined entity
is not a condition precedent to Hexion’s obligations under the merger agreement.113
In fact, looking only at terms of the merger agreement, Hexion’s avowed inability
to deliver a suitable solvency opinion does not negate its obligation to close: rather,
the receipt of such an opinion is merely a condition precedent to Huntsman’s duty
to close, protects Huntsman (and its shareholders), and is, therefore, waivable by
Huntsman. To put it differently, Hexion’s fear that it has agreed to pay too high a
price for Huntsman does not provide a basis for it to get out of the transaction.
The issue of solvency is only relevant to the obligation of the lending banks
to fund when the time comes for them to do so. Paragraph 6 of exhibit D to the
commitment letter makes it a condition precedent to funding that the lending banks
receive a reasonably satisfactory solvency letter in such form and substance as has
been customary in prior Apollo transaction. But Huntsman, in order to avoid or
ameliorate the very situation it now finds itself in, specifically bargained for and
obtained the right to have its CFO provide such a letter. Esplin, Huntsman’s CFO,
testified that he was prepared to provide the required letter. Moreover, it now
114 Although the court notes Credit Suisse’s admitted eagerness to avoid funding on thecommitment letter, as testified to by Malcolm Price, it also notes Price’s testimony that his bankis “prepared to fund that commitment if a compliant solvency certificate can be provided.” TrialTr. vol. 3, 753.
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appears that Huntsman has retained American Appraisal to furnish a back up
opinion to support such a letter.
Thus, there is only one point in time at which it is necessary to make a
determination of solvency—at (or as of) closing. For the reasons discussed
elsewhere in this opinion, the court is issuing a judgment and order that will
require Hexion to specifically perform its covenants and obligations under the
merger agreement (other than its obligation to close). Thus, if the other conditions
to closing are met, Hexion will be obligated to call upon the lending banks to
perform on their funding obligations. In that circumstance, the banks will then
have to choose whether to fund on the basis of the solvency letter delivered by
Huntsman or, instead, reject that letter as unsatisfactory and refuse to fund. If the
lending banks refuse to fund, they will, of course, be opening themselves to the
potential for litigation, including a claim for damages for breach of contract.114 In
such litigation, the prospective insolvency of the combined entity would likely be a
important issue.
If the banks agree to fund, Hexion will then have to determine whether it
considers it in its best interests to close the transaction, or instead refuse to close,
115 “Ripeness, the simple question of whether a suit has been brought at the correct time, goes tothe very heart of whether a court has subject matter jurisdiction. As such, the court has apositive duty to raise this issue on its own motion, even if neither party objects to the court’sexercise of power over the case.” Bebchuk v. CA, Inc., 902 A.2d 737, 740 (Del. Ch. 2006)(citing 15 JAMES WM. MOORE ET AL., MOORE’S FEDERAL PRACTICE ¶¶ 101.70[1], 101.73[2] (3ded. 2006)). Delaware courts do not rule on issues unless they are “‘ripe for judicialdetermination,’ consistent with a well-established judicial reluctance” to issue advisory opinions. Bebchuk, 902 A.2d at 740 (quoting Stroud v. Milliken Enterprises, Inc., 552 A.2d 476, 479-80(Del. 1989)). “Whenever a court examines a matter where facts are not fully developed, it runsthe risk not only of granting an incorrect judgment, but also of taking an inappropriate orpremature step in the development of the law.” Stroud, 552 A.2d at 480. A ripe dispute istherefore one not only where litigation “sooner or later appears to be unavoidable,” but in which“the material facts are static.” Id. at 481. The court must therefore decide as a threshold matter“whether the interests of those who seek relief outweigh the interests of the court and of justicein ‘postponing review until the question arises in some more concrete and final form.’” Bebchuk,902 A.2d at 740 (quoting Stroud, 552 A.2d at 480). In the court’s opinion, the latterconsiderations outweigh the former here.
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subjecting itself to the possibility of an additional finding of knowing and
intentional breach of contract and uncapped contract damages. If Hexion chooses
to close, the issue will be moot. If it does not, the posture of the matter, and the
decision presented to the court, will be far more concrete and capable of judicial
resolution than the issue now framed by the parties.
For the foregoing reasons, the court will not now resolve the question of
whether the combined entity would be solvent or not. That issue may arise in the
future in the course of this litigation or some related action, but it is not now
properly framed by the terms of the merger agreement and the status of the
transaction. Thus, the issue is not ripe for a judicial determination.115
116 Emphasis added. The Marketing Period is, in simplified terms, the first 20 consecutivebusiness days after the Initiation Date. The Initiation Date is the first business day after which
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V.
Huntsman asks the court to enter a judgment ordering Hexion and its merger
subsidiary, Nimbus, to specifically perform their covenants and obligations under
the merger agreement. For the reasons explained below, the court finds that, under
the agreement, Huntsman cannot force Hexion to consummate the merger, but that
Huntsman is entitled to a judgment ordering Hexion to specifically perform its
other covenants and obligations.
The court first examines whether the merger agreement, somewhat
unusually, contains a provision prohibiting the issuance of an order specifically
directing Hexion to comply with its duty to close the transaction. Section 8.11
provides that generally a non-breaching party may seek and obtain specific
performance of any covenant or obligation set forth in the agreement. However,
that section goes on to state, in virtually impenetrable language, as follows: “In
circumstances where [Hexion is] obligated to consummate the Merger and the
Merger has not been consummated on or prior to the earlier of the last day of the
Marketing Period or the Termination Date (other than as a result of [Huntsman’s]
refusal to close in violation of this Agreement) the parties acknowledge that
[Huntsman] shall not be entitled to enforce specifically the obligations of [Hexion]
to consummate the Merger.”116
the conditions precedent set forth in sections 6.1 and 6.2 (general conditions precedent andconditions precedent to Hexion’s obligation to close) have been met. Merger Agreement § 1.2.117 Trial Tr. vol. 2, 412. 118 Def.’s Post-Trial Br. 84. See 11 WILLISTON ON CONTRACTS § 32:5 (4th ed.) (“Aninterpretation which gives effect to all provisions of the contract is preferred to one whichrenders a portion of the writing superfluous, useless or inexplicable. A court will interpret acontract in a manner that gives reasonable meaning to all of its provisions, if possible.”).
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Hexion argues that section 8.11 entirely precludes specific performance as a
remedy for breach of its obligation to close. Andrew Nussbaum, a Wachtell Lipton
partner advising Hexion during the negotiation and drafting of the merger
agreement, testified that “[i]t was [Hexion’s] position that we would agree to
specific performance of our covenants under the agreement, with the exception of
the obligation to close the merger.”117 Nussbaum further testified that Huntsman
accepted Hexion’s position in the executed version of the agreement.
Huntsman did not question Nussbaum at trial regarding the parties’
understanding of the specific performance section and did not offer contrary
testimony by any of its lawyers. Instead, Huntsman attempts to undercut
Nussbaum’s testimony by arguing in its post-trial brief that the phrase “[i]n
circumstances where . . . [Huntsman] shall not be entitled to enforce specifically
the obligation[] of [Hexion] to consummate the Merger” implies that some other
circumstances must exist where specific performance of the obligation to close is
available; otherwise, Huntsman argues, the drafters simply would have written
“[u]nder no circumstances . . . shall [Huntsman] be entitled to enforce specifically
the obligations of [Hexion] to consummate the merger.”118 Huntsman then
119 Merger Agreement § 8.11 (emphasis added). 120 Assuming that the Marketing Period ends before the Termination Date, if the deal is notconsummated on or before the end of the Marketing Period, the agreement does not allowspecific performance of the obligation to close. The clause does not explicitly state whetherspecific performance is available after the Marketing Period and before the Termination Date. However, if the deal was still in need of specific performance, it follows that it also had not beenconsummated prior to the end of the Marketing Period–and thus no specific performance isavailable. Specific performance would technically be available if the merger had already beenconsummated (on or prior to the earlier of the last day of the Marketing Period or theTermination Date), but at that point specific performance would be wholly unnecessary. Assuming that the Termination Date ends before the Marketing Period, on or before the end ofthe Termination Date specific performance of the obligation to close is not available. After theTermination Date, the agreement is terminated and specific performance would not be possible.
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explains that the reason for the exception to its general right to demand specific
performance was to protect the Marketing Period during which the lending banks
were to syndicate the debt. Furthermore, Huntsman argues, the parties agreed that
if the Marketing Period had passed or the Termination Date had arrived Huntsman
could force Hexion to consummate the merger, as the lending banks would have
had a chance to syndicate the debt. While Huntsman’s argument makes
commercial sense, the inartfully drafted provision does not say what Huntsman
says it does.
The problem clause is the second condition to the carve-out from specific
performance: if “the Merger has not been consummated on or prior to the earlier
of the last day of the Marketing Period or the Termination Date,” Huntsman cannot
force Hexion to close.119 Literally the clause does not allow specific performance
in any case where Huntsman could employ the remedy.120
121 See Julian v. Eastern States Constr. Service, Inc., 2008 WL 2673300, at * 7 (Del. Ch., July 8,2008).122 “The extrinsic evidence the court may consider in such a circumstance includes ‘overtstatements and acts of the parties, the business context, prior dealings between the parties,business custom and usage in the industry.’” Comrie v. Enterasys Networks, Inc., 837 A.2d 1, 13(Del. Ch. 2003) (quoting Supermex Trading Co., Ltd. v. Strategic Solutions Group, 1998 WL229530 at *3 (Del. Ch. May 1, 1998)). 123 Huntsman Corp., Definitive Proxy Statement Relating to Merger or Acquisition (FormDEFM14A) at 11, 85 (September 12, 2007).124 If the clause was meant as Huntsman argues in its post-trial brief, it would be a rare case thatHuntsman would not be entitled to specifically enforce the consummation of the merger, given
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While generally Delaware courts attempt to interpret contracts in a manner
that gives meaning to each provision, the meaning of the phrase at issue is
unclear.121 When a provision is “fairly susceptible of different interpretations,” as
is the case here, “the court may consider extrinsic evidence.” 122 Here, Huntsman
merely offers an unsupported argument about what the parties intended to mean,
based on logic, but provides no evidence. In addition, Huntsman’s argument
contradicts how it explained the merger in the proxy statement it filed with the
Security and Exchange Commission. On both pages 11 and 85, Huntsman reports:
Each of the parties is specifically authorized to seek a decree or orderof specific performance to enforce performance of any covenant orobligation under the merger agreement or injunctive relief to restrainany breach or threatened breach, provided that in a case where Hexionis obligated to close the merger, we may not specifically enforce itsobligations to consummate the merger but only its obligations to causeits financing to be funded.123
The proxy statement makes no mention of any circumstance under which
Huntsman could specifically enforce Hexion’s obligation to consummate the
merger.124
that Huntsman’s brief suggests that the Marketing Period was envisioned to occur before theTermination Date. Even if the banks did not start the Marketing Period promptly, Huntsman,under its proffered interpretation, could always specifically enforce consummation of the mergeron the Termination Date. In sharp contrast, Huntsman’s proxy statement leads its shareholdersto believe that there are no (or possibly insignificant) circumstances under which Huntsmancould specifically enforce the consummation of the merger.125 In addition to the issues already dealt with above, the court also rejects Hexion’s claim, madein count IV of its amended complaint, that Huntsman’s board was not entitled to extend theTermination Date past July 4, 2008, and that the merger agreement is therefore presentlyterminable by Hexion. Hexion cites for this proposition section 7.1(b)(ii), which states, inpertinent part:
if as of the Termination Date (as extended pursuant to the second proviso of this Section7.1(b)(ii)), the condition set forth in the first sentence of Section 6.1(b) has not been met,the Termination Date shall be extended (provided, that commitments to provide theFinancing (or any Alternate Financing) shall have been extended to the proposedextended Termination Date and Parent and Merger Sub are in material compliance withSection 5.4 hereof) by 90 days, upon the request of Parent or the Company for suchextension, if the Board of Directors of the Company determines in good faith (afterconsultation with Parent), that there exists at such time an objectively reasonableprobability of both (A) the condition set forth in the first sentence of Section 6.1(b) beingmet and (B) the consummation of the Merger occurring within such subsequent 90 dayperiod (it being understood and agreed by the parties that any decision by the Board ofDirectors of the Company to not extend the Termination Date as provided in this thirdproviso shall in no way mitigate Parent’s obligations under Section 5.4).
Section 6.1(b) requires the receipt of any necessary antitrust and regulatory approvals as acondition precedent to closing. Section 7.1(b)(ii) therefore requires that Huntsman’s board, inorder to extend the Termination Date, make a “good faith determination” that there exists at thattime an “objectively reasonable probability” of (A) receiving antitrust clearance and (B) themerger closing within the 90-day extension. Hexion does not challenge Huntsman’s determination as to antitrust clearance. The onlyquestion, therefore, is whether the Huntsman board had, at the time it purportedly extended themerger agreement, determined in good faith that there was an objectively reasonable probabilityof the merger closing in the 90-day extension period. “Good faith” requires “‘a party in acontractual relationship to refrain from arbitrary or unreasonable conduct which has the effect ofpreventing the other party to the contract from receiving the fruits’” of the bargain. Dunlap v.
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Nussbaum’s uncontradicted testimony at trial coupled with the extrinsic
evidence provided in Huntsman’s own publicly filed proxy statement leads the
court to find that the agreement does not allow Huntsman to specifically enforce
Hexion’s duty to consummate the merger. Instead, if all other conditions precedent
to closing are met, Hexion will remain free to choose to refuse to close.125 Of
State Farm Fire and Cas. Co., 878 A.2d 434, 442 (Del. Super. 2005) (quoting Wilgus v. Salt
Pond Inv. Co., 498 A.2d 151, 159 (Del. Ch. 1985)). “Objectively reasonable probability” simplyrequires “something more than a ‘mere hope.’” Kachmar v. SunGard Data Systems, Inc., 109F.3d 173, 184 (3d Cir. 1997). Thus, the standard for Huntsman’s conduct in extending theTermination Date is that the Huntsman board may not have arbitrarily or unreasonably extendedon the basis of a mere hope that the merger could be consummated within the 90-day window. This is a very low bar for Huntsman to meet, and it does so quite easily here. Ramsey presented to the Huntsman board on behalf of Merrill Lynch on June 26 that Duff &Phelps’s opinion was potentially untrustworthy as it did not reflect Huntsman’s actual andexpected earnings, and that Merrill Lynch believed that a good case could be made for thesolvency of the combined entity. Hexion, in response, puts a great deal of stock in the analysisperformed by Esplin on July 1, 2008 showing a $53 million funding gap and only $10 million inrevolver availability in Q1 2009. However, as was made clear at trial, Huntsman’s workingcapital, and therefore net debt, swung as much as $100 million over the course of a month. The$53 million gap is therefore within the margin of error created by the level of working capital,and at closing the funds required to close could potentially have been that much less. This alsoignores the possibility of other “levers” being pulled by Huntsman in order to buttress thesolvency of the combined company, including the presently outstanding offer of “free money”by the Huntsman family to be injected into the company at closing. Such injected “equity”would not only alleviate the $53 million funding gap but would increase the availability of therevolver by whatever amount the injected funds exceeded the funding gap at closing. In anyevent, Huntsman has a very low bar to clear in order to be justified in extending the TerminationDate, and the fact that Esplin had in hand a single model which potentially called into questionthe solvency of the combined entity did not prevent Huntsman from doing so. Moreover, even if, arguendo, Huntsman had not been able to make its showing of good faith,section 7.1(b)(ii) provides that, notwithstanding the Termination Date, “the right to terminatethis Agreement under this section 7.1(b)(ii) shall not be available to any party whose failure tofulfill any material covenant or agreement under this Agreement has been the cause of orresulted in the failure of the Merger to occur on or before such date . . . .” Given the finding ofthis court that Hexion knowingly and intentionally breached its covenants under sections 5.12and 5.13 of the merger agreement, and likely breached its covenant under section 5.4 as well,and that it is these breaches that have until now prevented the consummation of the merger,Hexion is not, in any event, entitled to terminate the merger agreement.
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course, if Hexion’s refusal to close results in a breach of contract, it will remain
liable to Huntsman in damages.
Turning to the remaining questions, there is no dispute that section 8.11 of
the merger agreement reflects the parties’ express agreement that irreparable injury
would occur “in the event that any of the provisions of this Agreement were not
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performed in accordance with its specific terms or were otherwise breached.” That
same section also contains the parties’ general agreement that, in the event of any
breach, the non-breaching party shall be entitled to obtain an order of specific
performance “to enforce the observance and performance of such covenant or
obligation.” Finally, section 8.11 provides that no party seeking an order of
specific performance “shall be required to obtain, furnish or post any bond or
similar instrument.”
In view of these provisions, and considering all the circumstances, the court
concludes that it is appropriate to require Hexion to specifically perform its
obligations under the merger agreement, other than the obligation to close. Hexion
does not argue otherwise. When it is known whether the financing contemplated
by the commitment letter is available or not, Hexion and its shareholders will thus
be placed in the position to make an informed judgment about whether to close the
transaction (in light of, among other things, the findings and conclusions in this
opinion) and, if so, how to finance the combined operations. As the parties
recognize, both Hexion and Huntsman are solvent, profitable businesses. The
issues in this case relate principally to the cost of the merger and whether the
financing structure Apollo and Hexion arranged in July 2007 is adequate to close
the deal and fund the operations of the combined enterprise. The order the court is
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today issuing will afford the parties the opportunity to resolve those issues in an
orderly and sensible fashion.
VI.
For all the foregoing reasons, the court has today entered an Order and Final
Judgment granting Huntsman Corporation relief in accordance with the findings of
fact and conclusions of law set forth in this Opinion.