Unenforceability of Indefinite Indemnification Obligations

A recent court decision by the Delaware Court of Chancery has found unlimited indemnification obligations unenforceable against stockholders who have not signed the merger agreement.  Cigna Health and Life Ins. Co. v. Audax Health Solutions, Inc., C.A. No. 9405-VCP, 2014 WL6784491 (Del. Ch. Nov. 26, 2014). Defendant closed a Section 251 merger with the requisite board/stockholder approval, however, Plaintiff, a stockholder of Defendant, did not vote in favor of the merger. One of Plaintiff’s claims was that the indefinite indemnification obligations of stockholders set forth in the merger agreement violated Section 251 of the Delaware General Corporation Law because it effectively made the stockholders liable for the debts of the company. Defendants contended that that the indefinite indemnification obligations were similar to that of an escrow agreement, which is well accepted as enforceable.

The Delaware Court of Chancery found that the lack of temporal and monetary restrictions on the indemnification obligation was more akin to a post-closing adjustment rather than an escrow agreement.  Section 251(b) provides that the terms of the merger agreement are dependent on facts ascertainable within the four corners of the merger agreement.  Given that the indemnification obligation at issue were not fully ascertainable as they continued indefinitely and with no monetary cap, such indemnification obligation violated Section 251.

It is typical for certain “fundamental representations” in a merger agreement to survive indefinitely. These include representations related to organization, authorization, capitalization, and brokerage fees, and can often include tax, environmental and intellectual property representations. The Cigna-Audax decision highlights that, at this point, it looks far preferable to state a specific time period (e.g., five years) and monetary limit in the merger agreement for fundamental representations rather than to default to indefinite survival and unlimited obligation. This decision will necessitate a change for many M&A attorneys.

Leave a Reply

Your email address will not be published. Required fields are marked *