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HLSP Holdings v. Fortune Management: ConEd Issues Are Alive and Well in Delaware
HLSP Holdings v. Fortune Management: ConEd Issues Are Alive and Well in Delaware
Here is analysis of a recent decision from Kevin Miller of Alston & Bird: In HLSP Holdings v. Fortune Management, the Delaware Superior Court recently granted a motion for summary judgment by the defendant, Fortune Management, against a claim by plaintiff, HLSP Holdings, based on Fortune's alleged failure to fulfill its obligations under the acquisition agreement to cause the shares that it had issued to HLSP in exchange for substantially all of HLSP's assets to be registered and freely tradeable. The Superior Court held that HLSP did not have standing to sue Fortune because HLSP could not show that HLSP, rather than its shareholders, was injured by Fortune's alleged breach of its obligations under the acquisition agreement.
In July 2005, HLSP Holdings agreed to sell substantially all its assets to a subsidiary of Fortune Management in exchange for shares of Fortune common stock. Pursuant to the acquisition agreement, the parties agreed that (i) HLSP would liquidate and distribute the shares of Fortune stock to HLSP's shareholders promptly following the closing of the transaction and (ii) Fortune would take all necessary actions to cause the shares to be registered and freely tradable on the Frankfurt Stock Exchange.
The shares of Fortune common stock were issued to HLSP in September 2005 and distributed by HLSP to its five shareholders in March 2006. However, the shares did not become freely tradable and consequently could not be sold until August 2007 at which time the market price for shares of Fortune common stock had fallen below 1 euro per share. In the interim, shares of Fortune common stock had traded for more than 4 euros per share during the fourth quarter of 2006 and the first quarter of 2007.
HLSP sued Fortune alleging that Fortune's breach of its obligations under the acquisition agreement to take all necessary actions to cause the shares to be registered and freely tradable had resulted in over 40 million euros in damages.
The Court held that "[f]undamental to having standing to bring a cause of action in the Superior Court is the requirement that the plaintiff has suffered monetary injury caused by the party that they are attempting to sue. . . . the Court finds that HLSP is not conferred standing solely by virtue of its status as a contracting party in the absence of any showing of injury."
According to the Superior Court, the "fundamental flaw of the Plaintiff's argument [was] that the Stock had no value to [HLSP] as [HLSP was] required to distribute it to the shareholders." HLSP could not have suffered damages because it never had the right to sell the shares - instead it was required to distribute the shares to its shareholders - and it did not possess the shares during the relevant time period, having distributed the shares in March 2006, well before the value of the shares peaked.
A Reflection on ConEd
This result is strikingly similar to the outcome at the District Court level in ConEd. As you may recall, ConEd involved a suit in the Federal District Court for the Southern District of New York brought by a target corporation seeking monetary damages under New York law for its shareholders' lost merger premium. Shareholders of the target successfully intervened, claiming that the target's shareholders rather than the target, itself, were the proper plaintiffs in an action for lost merger premium and the target's suit was dismissed.
However, upon appeal of the District Court's refusal to dismiss the shareholder suit for lack of standing, the Second Circuit held that the target shareholders were not intended third-party beneficiaries of the merger agreement prior to the consummation of the merger and consequently lacked standing to pursue their claim for lost merger premium against the acquiror.
For many, the takeaway from the ConEd decisions is that, with respect to monetary damages for lost merger premium (i) the target can't sue for its shareholders' lost merger premium under NY law because, though it was a party to the merger agreement, the target was never entitled to the lost merger premium and thus lacked demonstrable damages other than its transaction expenses and (ii) shareholders can't sue on a merger agreement for their lost merger premium under NY law if they are not intended third-party beneficiaries under the merger agreement at the time the claim arose.
Following the ConEd decisions, commentators questioned whether the ConEd holdings under New York law would be followed by the Delaware Courts applying Delaware law. In addition, they noted that the Second Circuit was not called upon to address, and did not address, whether a target could sue for specific performance - i.e., equitable relief instead of monetary damages - to obtain its shareholders' lost merger premium or whether such suit should be dismissed because the only alleged harm was to its shareholders who were not intended third party beneficiaries under the merger agreement. See this October 2006 article, entitled "The ConEd Decision - One Year Later: Significant Implications for Public Company Mergers Appear Largely Ignored."
The HLSP Decision in Relation to ConEd
The HLSP decision appears to indicate that the Delaware Superior Court will follow the District Court's reasoning in ConEd with respect to actions by a target seeking monetary damages for its shareholders' lost merger premium.
It is less clear whether the Delaware Chancery Court would follow the Second Circuit's holding in ConEd. In Amirsaleh v. Board of Trade of The City of New York, the Delaware Chancery Court addressed claims by a member of the target that the parties to a merger agreement did not act in good faith in implementing the provisions of the merger agreement permitting members of the target to elect the form of consideration to be received in a merger. As an initial matter, the Delaware Chancery Court had to determine whether or not the member had standing to bring a claim in respect of the merger agreement. Despite unambiguous language in the Amirsaleh merger agreement that "[e]xcept as provided in Section 6.13 (Indemnification; Directors' and Officers' Insurance), this Agreement is not intended to, and does not, confer upon any Person other than the parties who are signatories hereto any rights or remedies hereunder," the Delaware Chancery Court refused to grant defendants' motion for summary judgment holding that "there is little legitimate question that the members of [the target] were intended beneficiaries of the Merger Agreement."
Specific Performance: A Separate - But Related - Issue Not Addressed by HLSP or ConEd
It also remains to be seen how the Delaware Courts will rule on actions seeking specific performance as a remedy for breach of a cash merger agreement where the only alleged harm is the target shareholders' lost merger premium.
Some commentators have worried that if courts are not willing to grant specific performance to prevent a harm to non third party beneficiary shareholders, buyers will be able to breach merger agreements with virtual impunity. Others have raised concerns regarding a strict "contractarian" approach that would require courts to grant specific performance where sophisticated parties to a merger agreement have specifically agreed that such a remedy was appropriate regardless of arguments that the target itself had not been harmed, that target shareholders were not intended third party beneficiaries or that monetary damages would, at least theoretically, be an adequate remedy.
Still others have suggested that the fault, if any, was not with the Second Circuit's reasoning, but in the way parties have traditionally drafted the merger agreements. The ConEd article referenced above and other subsequent articles discussing the case, have offered various suggestions for revising the third party beneficiary and remedy provisions of merger agreements to clarify whether it is the actual intent of the parties that the target be able to seek specific performance or monetary damages on its shareholders behalf.
However, to date, none of these suggested alternatives have been reviewed by the courts and it remains to be seen whether they would be effective.
An alternative approach that would permit targets to obtain specific performance of a cash merger would be for targets to broaden their complaints to include allegations of direct injuries to the target (e.g., as a result of the announcement of the transaction and/or compliance with the terms of the merger agreement so that they wouldn't count towards a MAC).
Though not generally commented upon, Genesco, in its Tennessee action against Finish Line seeking specific performance of a cash merger, alleged direct harms to itself, rather than just shareholders' lost merger premium, as a basis for requesting specific performance. Such claims are easily made in stock for stock mergers where the target will directly benefit from cost savings and synergies but, as evidenced by Genesco, can also be made in connection with cash mergers.
The court in Genesco found that "[t]he testimony established that Genesco's business has been irreparably harmed as a result of the stalled merger. Genesco's business is in a state of limbo. Uncertainty has negatively affected its stock price, vendor relationships, employee morale, public perception, and virtually every other aspect of its business during the pendency of the merger and this litigation. Due to restrictions that the Merger Agreement imposes on its activities pending closing, it has been unable to open new stores, make significant capital expenditures, and otherwise engage in ordinary business activities that would be inconsistent with Finish Line's plan for Genesco but that would be necessary or desirable for an independent Genesco. For example, Genesco had planned to pen a west coast distribution facility that would have reduced the lead time to Genesco's stores on the West Coast and otherwise improve Genesco's west coast inventory management, affecting inventory and sales in its stores. . . . These facts proven at trial establish irreparable harm and that the payment of damages is not an adequate remedy."
To date, it does not appear that targets in actions seeking specific performance of cash mergers under Delaware law (e.g., URI v. RAM and Valassis v. Advo) have similarly alleged direct harms to the target in addition to their shareholders' lost merger premium to bolster their claims for specific performance.
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