United States: Colorado M&A Update: Courts Provide Guidance on Dissenters’ Rights and Break-Up Fee Issues

As most Colorado attorneys know, there are very few cases addressing merger and acquisition issues under Colorado law. As a result, two recent appellate decisions regarding dissenters’ rights and break-up fees should prove to be quite instructive for companies engaging in M&A activities in Colorado.

Dissenters’ Rights Issues:

The decision by the Colorado Supreme Court in the Szaloczi v. John R. Behrmann Revocable Trust, 90 P.3d 835 (Colo. 2004) case should make it more difficult for dissenting shareholders of a Colorado corporation to sue directors and officers in the merger and acquisition context. In this case, the court addressed the question of whether a shareholder who dissents from a sale of corporate assets and seeks payment for the fair value of its shares also may pursue a separate claim for compensatory damages against the officers and directors of a Colorado corporation for breaching their fiduciary duties in connection with the sale. In upholding the dismissal of the minority shareholder’s action, the Supreme Court determined that the statutory appraisal remedy provided by Colorado’s dissenters’ rights statute generally provides an exclusive remedy at law.

Colorado corporate law has long provided minority shareholders of Colorado corporations with a statutory right to dissent from certain corporate actions, including mergers and -- unlike many other states such as Delaware -- sales of substantially all of a corporation’s assets. In lieu of the consideration to which a party otherwise would be entitled to in a sale, dissenting shareholder are entitled to receive the "fair value" of their shares of stock. Shareholders who desire to exercise their dissenters’ rights must follow the detailed procedures and satisfy all the conditions set forth in the Colorado Business Corporation Act (the "CBCA").

In Szaloczi, before the minority shareholder delivered its demand for payment required by the CBCA, it filed an action against the officers and directors of the corporation for breach of fiduciary duty and conspiracy to deprive it of the value of its shares. The complaint sought compensatory damages rather than equitable relief (e.g., an injunction to prevent the sale from occurring or for rescission).

The Colorado Supreme Court held that the action for damages against the officers and directors could not proceed as a result of the "Exclusivity Provision" set forth in Section 7-113-102(4) of the CBCA, which provides:

In so holding, the Court read the "unlawful and fraudulent conduct" language very narrowly and determined that to fall within the exception rather than the general exclusivity rule, a party must file a complaint seeking equitable relief (meaning the plaintiff may seek only to block the transaction or seek rescission but not receive additional compensatory damages).

Though the minority shareholder only sought to challenge the directors’ specific actions in connection with the sale that gave rise to the right to dissent, the Colorado Supreme Court stated that following the effective date of the relevant corporate action, a dissenting shareholder’s only right is to receive payment for the shares. Under a literal reading, this case would foreclose a dissenting shareholder from bringing or continuing any action in their capacity as a shareholder for compensatory damages following the effective date of the event that gave rise to dissenters’ rights, even if the pre-existing claim and challenged action is wholly unrelated to such triggering event.

The Szaloczi decision represents a significant victory for officers and directors of Colorado corporations involved in acquisitions and generally should provide a great amount of protection, particularly against monetary claims. As a practical matter, this case will force minority shareholders who believe there is fraudulent conduct to promptly determine whether to file an equitable action seeking an injunction to block the potential transaction from occurring or for rescission to restore the parties to the status quo.

Based on the foregoing considerations, it remains important for parties to use experienced counsel familiar with Colorado principles governing dissenters’ rights (which in many cases differ from the appraisal rights provisions of Delaware law) in circumstances where such rights may be triggered and to prevent otherwise valid claims or remedies from being lost.

Break-Up Fee Issues:

A separate decision issued in 2004 by the Colorado Court of Appeals similarly highlights the importance of using experienced counsel familiar with Colorado principles that govern mergers and acquisitions.

In spring 2002, the owner of Steamboat ski resort, Maine-based American Skiing Co. entered into a definitive purchase agreement to sell the ski resort to Triple Peaks, LLC for approximately $87 million. All conditions to the closing were satisfied and the parties scheduled a closing date. But the owner refused to show up for the closing. Instead, it sent the prospective buyer a check for $500,000 as "liquidated damages," relying on a provision in the "Termination" section of the purchase agreement.

The prospective buyer sued to enforce the contract and force the sale of the resort. The trial court rejected this claim, ruling that the purchase agreement’s language was "clear and unambiguous," and that the $500,000 liquidated damages payment was the prospective buyer’s sole remedy under the purchase agreement. The Colorado Court of Appeals disagreed and reversed the trial court’s decision. It held that Triple Peaks, LLC could seek specific performance to enforce the sale.

According to the appellate court, the owner improperly relied on a liquidated damages provision that applied only if the Buyer terminated the agreement after the owner’s breach. Because the agreement never was terminated, even after the owner failed to show up for the closing, the liquidated damages provision was not triggered.

Termination provisions that specify liquidated damages, sometimes called "break-up" fees, are common in purchase agreements for sales of businesses located in Colorado. Their purpose is to avoid protracted litigation if one party refuses to close the sale (particularly in circumstances where that party subsequently sells the business). The amounts of break-up fees are carefully negotiated to ensure that the party left standing at the altar is adequately compensated for its time, effort and lost opportunity. These provisions require special attention by the parties’ lawyers. If the termination provisions, remedy provisions, closing conditions, and liquidated damages provisions do not all work together seamlessly, the parties easily can end up in costly and protracted litigation, as happened in the Steamboat case.

Parties also must carefully negotiate the amount, nature, and triggering factors for break-up fees. If a break-up fee is classified as liquidated damages under Colorado law and the amount set is too high or too low, it may be unenforceable. Colorado courts previously have required that liquidated damages reflect a "reasonable estimate" of the presumed actual damages. And under Colorado law, liquidated damages provisions – which apply only if one party breaches an agreement – may be treated differently than true termination fees, which are designed to apply only in the absence of any breach of the agreement. Moreover, whatever its classification, if a break-up fee is set too high, it may be unenforceable because it prevents a seller’s board of directors from fulfilling its fiduciary duty to give due consideration to competing offers to buy the business.

When drafted carefully and coherently, and in light of recent Colorado court decisions, break-up fees can provide a clean and mutually beneficial method of terminating a purchase agreement. But if the parties are not careful, they can end up in lengthy litigation, which (among other problems) can prevent a seller from selling its business to another suitor, or prevent the buyer from pursuing other targets, while the lawsuit drags on.