A recent posttrial decision from
Background
In
Marquez based his claim on a 2004 software agreement with the OpticalTel subsidiary
Subsequently, in an attempt to redress the Marquez situation, Sellers implemented a "Transfer-Dissolution Plan." Under this plan, Sellers transferred the software assets of the OpticalTel subsidiary in which Marquez claimed an interest to a parent company and then dissolved the subsidiary. Sellers placed in trust an amount believed to be sufficient to satisfy Marquez's claims, and Bustamante provided a personal indemnity for any excess.
As is customary, the merger agreement included interim operating covenants requiring Sellers to operate the OpticalTel group in the "ordinary course of business" between signing and closing in all material respects, and to use commercially reasonable efforts to preserve intact in all material respects the present business organizations of the OpticalTel group. Buyers did not consent to the Transfer-Dissolution Plan and claimed that the plan violated the interim operating covenants.
After the parties failed to resolve their differences, Buyers terminated the merger agreement. Sellers then filed suit for specific performance and claimed that Buyers failed to use their contractually mandated best efforts to close the transaction.
The Court's Decision
With Buyers' debt commitment expiring on
Sellers' Breach of Capitalization Representation
The capitalization representation of the merger agreement extended to both "
Without there being any sort of qualifying limitation to the capitalization representation, the court concluded that the representation had been breached and that the breach entitled Buyers to terminate the merger agreement. The court added that Buyers did have reason to be concerned with Marquez's claims because of possible post-closing reputational harm. The extent to which this conjecture contributed to the court's decision is unclear.
Sellers Did Not Breach Interim Operating Covenants
The court's rejection of Buyers' claim that Sellers' Transfer-Dissolution Plan violated the interim operating covenants of the merger agreement is also instructive. The court observed that even after giving effect to the plan, the OpticalTel business continued to hold and enjoy the use of the critical software that Sellers had sought to put out of reach of Marquez's claims. The software had simply moved to a different entity in the OpticalTel business group. The business continued to operate in the ordinary course, as a telecommunications company with long-term contracts to render services to communities in
Unlike the capitalization representation, the covenant to operate in the ordinary course did contain an "in all material respects" qualifier. The court observed, citing case law, that the "general purpose of an ordinary-course-of-business covenant is to 'help ensure that the business the buyer is paying for at closing is essentially the same as the one it decided to buy at signing.'" Because the machinations of the Transfer-Dissolution Plan had no real effect on the availability to the business of the critical software, the court failed to see any material change in the business between signing and what would have been the closing.
Buyers' claim that the plan violated the contractual requirement to maintain the present business organizations of the OpticalTel group fared no better. Citing case law, the court stated that "[p]reserving a business organization requires a company to maintain the operations and relationships inherent in a business structure. 'Gutting' a business organization does not satisfy the requirement to preserve it." As neither the transfer of the software to a different entity in the group nor the dissolution of the entity that originally held the software altered the business of OpticalTel group, the group was hardly being gutted. Accordingly, the court held, Sellers did not fail to maintain intact the OpticalTel group in all material respects.
Buyers Did Not Violate Their 'Best Efforts' Obligation
Finally, the court concluded that Buyers had not breached the merger agreement by failing to use best efforts to close the deal.
The court offered some principles for analyzing compliance with a best-efforts covenant. A best-efforts clause, the court said, citing case law, "does not 'require the identified outcome. Rather, it requires parties to try to achieve the identified outcome.' Even a 'best efforts' obligation 'is implicitly qualified by a reasonableness test — it cannot mean everything possible under the sun.'" Consistent with this reasonableness standard, the court stated that a "best-efforts provision does not require Buyers to sacrifice their negotiated contractual rights to solve a breach." Buyers negotiated for a flat capitalization bring-down, which was not overridden by the best-efforts covenant.
The court was also persuaded that Buyers did not have "cold feet." The court cited numerous indicia that Buyers were interested in the business even after the Marquez interest had been disclosed, although the last of these indicia was over a month before Buyers served their notice of termination. There is some implication that, notwithstanding the cited principles underlying the best-efforts covenant, buyer's remorse could be a factor in determining whether enforcement of a breach might contravene best efforts.
Analysis and Takeaways
The
Moreover, there may have been other considerations contributing to the court's decision. The court was persuaded that Buyers did not have remorse with respect to the business itself, and that there was at least some plausible breach-related reason for their decision to terminate. Buyers, the court found, did not want to be associated post-closing with Marquez's dogged claims and the potentially attendant reputational harm. This leaves open the possibility that a court might set a higher walk-away bar when terminating for an immaterial breach of a flat representation was patently pretextual for the buyer's unrelated business remorse.
It is worth observing that even with a materiality qualifier, a facially immaterial breach of a capitalization representation might get swept up in the bringdown. An undisclosed, otherwise insignificant interest in a subsidiary of the target could potentially constitute a material breach of a capitalization representation, where the acquirer does not have the ability to cash out the minority.
There is also something to be learned from the court's other holdings. To serve as a basis for termination of a merger agreement, a breach of the interim operating covenants must have a cognizable effect on the business of the seller. The result of the breach must be such as to render the business materially different from the one the buyer thought at signing that it would be getting. This is not all that surprising, since these covenants are typically qualified by materiality, as they were in this case.
The court's approach to the obligation of the parties to a merger agreement to use best efforts to close is also instructive. As has been the case in other contexts in
Had the court had more time to render its opinion in
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