Termination Fee Exclusivity Does Not Apply to No Shop Breach
September 19, 2019

Merger agreements entered into by Delaware corporations commonly include fiduciary out provisions in order to satisfy director fiduciary duty requirements to secure the best value reasonably available to stockholders under the Revlon rule.  The fiduciary out provision is usually accompanied by a no shop (or non-solicitation) covenant and a termination (or break-up) fee if the agreement is terminated because of a superior proposal.  The termination fee normally is stated to be the exclusive remedy if the agreement is terminated.

The question arose in a recent Delaware Court of Chancery decision whether the termination fee is the exclusive remedy for a target company’s breach of its no shop covenant that resulted in a termination of the merger agreement due to a proposal from a third party allegedly solicited and accepted in violation of the no shop covenant.  In Genuine Parts Company v. Essendant Inc.,[1] the Court of Chancery, in denying the defendant’s motion to dismiss, ruled that the termination fee was an exclusive remedy only if the merger agreement in that case was terminated because of a superior proposal received in compliance with the provisions of the agreement and not when there is a breach of the no shop covenant.  In addition, the Court ruled that acceptance of the termination fee did not foreclose the plaintiff from seeking additional damages for breach of contract.  This ruling makes sense because the very purpose of the no shop covenant is to prevent the target from affirmatively seeking a third-party proposal after entering into the agreement but instead to allow its directors to fulfill their fiduciary duties in the event of an unsolicited superior proposal by a third party.

The Court indicated that in order for the termination fee to be the exclusive remedy (i.e., liquidated damages) in the event of a breach of the no shop covenant, the agreement would have to clearly so provide, which it did not do in this case.  However, such a provision is unlikely to be acceptable to a potential buyer, at least without the amount being significantly higher than the customary termination fee.  This is in contrast to a liquidated damages provision in an exclusivity agreement during negotiations because of the uncertainty of the right to damages or the amount of such damages before a merger agreement is signed.

Sellers should recognize that an exclusive termination fee is unlikely to limit damages for a breach of the provisions of a merger agreement and therefore they should strictly comply with those provisions, particularly in dealing with other proposals that may be received after signing.  As the Genuine Parts decision indicates, what is an impermissible solicitation may not always be obvious and therefore careful planning is important.  Buyers, correspondingly, should be aware of the contractual rights that they may have if their agreed upon transaction should be trumped by another bidder.

[1] ‎C.A. No. 2018-0730-JRS (Del. Ch. Sept. 9, 2019)‎.

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