Lost-Premium Damages Under Merger Agreement – Proposed Amendment To The DGCL In Light Of Crispo vs. Musk

On March 28, 2024, the Council of the Corporation Law Section of the Delaware State Bar Association ("DSBA") issued proposed amendments to the Delaware General Corporation Law ("DGCL"), which, if signed into law, would become effective on August 1, 2024. One of the proposed amendment stems from Crispo v. Musk, C.A. No 2022-0666-KSJM, 2023 WL 7154477 (Del. Ch. Oct. 31, 2023), in which a Twitter stockholder alleged that Elon Musk and related entities breached fiduciaries duties as a controller and violated the Twitter/Musk merger agreement (until Elon Musk decided to close the merger anyway). In this case, the Delaware Court of Chancery addressed the enforceability of "lost-premium damages" provisions, which provides that stockholders can recover lost premium damages when buyer is in breach.

This is an issue that actually dates back to the seminal 2005 ruling of the United States Court of Appeals of the Second Circuit in Consolidated Edison, Inc. v. Northeast Utilities, 426 F.3d 524 (2d Cir. 2005) ("Con Ed"). In that decision, the Second Circuit held that by virtue of the existence of a provision in the merger agreement prohibiting third-party rights, stockholders of the target company lacked standing to recover lost premium damages arising from the pre-closing breach by the buyer of the merger agreement. As a consequence, the Con Ed ruling could permit prospective buyers to walk away from a busted deal with no consequences. Practitioners, therefore, adapted and thus were born the "standard" Con Ed provisions in merger agreements to bar the effect of the Con Ed ruling. There have been three different types of "Con Ed" provisions: the target company's damage definition would include lost premium damages; the target company would act as agent of its stockholders to seek lost-premium damages; or the target's stockholders would be express third-party beneficiaries under the merger agreement.

In Crispo, the issue at hand was the enforceability of the first variation of these "Con Ed" provision, i.e., can a target company's damages definition include its stockholders' lost-premium damages? The Court of Chancery answered in the negative, holding that a "target company has no right or expectation to receive merger consideration, including the premium" and that "only a stockholder expects to receive payment of a premium under the [m]erger [a]greement." The court further indicated that "[w]here a target company has no entitlement to a premium in the event a deal is consummated, it has no entitlement to lost-premium damages in the event of a busted deal" and concluded that "a provision purporting to define a target company's damages to include lost-premium damages cannot be enforced by the target company."

Based upon Crispo, the DSBA proposed a new Section 261(a)(1) be added to the DGCL that would allow a merger agreement to provide that the target is entitled to seek damages (including lost premium damages) if the buyer were to fail consummate the merger per the terms of the merger agreement. Therefore, it would not be necessary under Delaware law to contractually appoint the stockholders of the target as third-party beneficiaries nor appoint the target company as an agent on behalf of such stockholders.

In connection with new Section 261(a)(1), the DSBA has also proposed a new Section 261(a)(2) to address whether merger agreement may include provisions appointing a stockholders' representative to protect rights of stockholders of the target entity without the express consent of each such stockholder. This provision would enable a stockholder representative appointed under a merger agreement to enforce the stockholders' rights to payment of merger consideration or in respect of escrow or indemnification arrangements and settlements. However, the proposed new Section 261(a)(2), expressly carves out from the stockholders' representative powers the ability to waive, compromise, or settle any rights to appraisal or assert any direct claim for breach of fiduciary duty or consent to restrictive covenants, in each case, without the consent of the named stockholder.

If the proposed amendment is enacted, companies should consider appointing a stockholders' representative in their merger agreements, as doing so will provide greater security to their stockholders and likely prevent long and costly litigation on this specific issue.