United States: Delaware Court Invalidates Target Stockholders’ Post-Closing Indemnification Obligations To The Buyer In Private Company Merger Transaction: Cigna Health And Life Insurance Co. V. Audax Health Solutions, Inc.

Last Updated: March 11 2015
Article by John J. McDonald, David I. Meyers and Michael Weinsier

In an important decision for private equity funds and strategic buyers of privately-held companies in M&A transactions, the Delaware Chancery Court in Cigna1  invalidated two common provisions in agreements governing private company merger transactions: (1) the post-closing indemnification obligations relating to "fundamental" representations of indefinite duration and potentially for the entire amount of the merger consideration; and (2) a release of claims contained in the letter of transmittal, rather than in the merger agreement. As discussed below, the Cigna decision provides important guidance on the steps that buyers of privately-held companies using a merger structure can take to secure enforceable post-closing indemnification and claims release obligations from target stockholders.

In Cigna, Optum Services, Inc. (Optum) acquired by merger Audax Health Solutions, Inc. (Audax).  Cigna Health and Life Insurance Company (Cigna) was a large preferred stockholder of Audax. The merger was approved by the requisite number of Audax stockholders by written consent set forth in support agreements. To receive their merger consideration, Optum required the former stockholders of Audax to execute a letter of transmittal in connection with surrendering their Audax shares following consummation of the merger. Cigna did not sign a support agreement (meaning it did not vote in favor of the merger transaction) and it refused to execute the letter of transmittal in order to receive its merger consideration.

The Cigna court held that the particular terms of the Audax stockholders' indemnification obligations to Optum (discussed below) made the amount of merger consideration receivable by Audax stockholders in connection with the merger transaction impermissibly uncertain, violating Delaware law. The Cigna court also ruled that the release of claims provision contained in the letter of transmittal was unenforceable for lack of consideration because it was imposed after consummation of the merger and was not referenced in the merger agreement.2 

The Cigna court's decision hinged on the provisions in the Optum/Audax merger agreement, carving out the Audax stockholders' indemnification obligations to Optum for losses resulting from breaches of Audax's "fundamental" representations and warranties from the time limits for indemnity claims to generally be brought after closing (18 months, generally, and 36 months for intellectual property representations) and the indemnity cap generally applicable to losses resulting from breaches of Audax's representations and warranties in the merger agreement.

As is typical in M&A transactions structured as mergers, the only signatories to the Optum/Audax merger agreement were Optum, its merger subsidiary and Audax; the majority Audax stockholders signed a separate support agreement in which they approved the merger transaction and agreed to be subject to the merger agreement's terms. Further, to receive the merger consideration for their shares, Audax stockholders were required to sign letters of transmittal in which they agreed to be subject to the terms of the merger agreement. Cigna, which wasn't one of the signatories of the support agreement, refused to sign a letter of transmittal and successfully argued that the post-closing indemnification obligation in the merger agreement was not binding on it "by operation of law," by virtue of the merger, because that indemnification obligation violated the requirement in Section 251 of the Delaware General Corporation Law.  

Section 251 requires that the merger consideration payable to stockholders either be specified in the merger agreement or be calculated based on "facts ascertainable" outside of the merger agreement. The Cigna court held that the "facts ascertainable" test was not satisfied because there was no time limit after closing by which Optum was required to make an indemnification claim against the Audax stockholders relating to "fundamental" representations and the Audax stockholders' indemnification obligations relating to those representations were only capped at their full pro rata consideration received in connection with the merger. As a result, the Cigna court held, Audax stockholders could, at any point after closing, potentially be required to return all of their merger consideration to Optum, rendering the actual amount of merger consideration receivable for their shares undeterminable.

The Cigna court's decision was somewhat surprising because the Delaware Chancery Court has previously upheld a merger transaction in which part of the merger consideration was placed into escrow to satisfy the target stockholders' post-closing indemnification obligations to the buyer, in its 2011 decision in In re OPENLANE Shareholders Litigation, 3 noting that "escrows are relatively common in deals for private companies." In addition, in Aveta v. Cavallieri,4 the Delaware Chancery Court upheld a merger transaction in which post-closing purchase price adjustments could have resulted in the target stockholders being required to return some of their merger consideration to the buyer.

Perhaps in light of those precedents,5 the Cigna court was careful to state that it was rendering a "limited holding" that did not address the validity of merger transactions in which the target stockholders' post-closing indemnification obligations to the buyer are satisfied out of an escrow fund consisting of part of the merger consideration (like in OPENLANE) or the validity of merger transactions with post-closing purchase price adjustments that could require the target stockholders to return some of their merger consideration to the buyer (like in Aveta). The Cigna court also stated that a merger imposing post-closing indemnification obligations on the target stockholders could be allowable if their exposure was limited to a specified time period after closing, even if their potential indemnity obligations were capped only at their full merger consideration amounts. Alternatively, a merger in which the target stockholders' indemnification obligations extended for an indefinite period of time after closing, but were subject to an indemnity cap of less than their full merger consideration amounts, could be allowable. However, the Cigna court held that the combination of an indefinite time period coupled with a potential full merger consideration indemnity cap rendered the indemnification obligation provisions unenforceable against Audax stockholders, such as Cigna, that did not sign the support agreement or a letter of transmittal in which they agreed to be subject to the merger agreement's terms. Importantly, the Cigna court's holding did not affect the post-closing indemnification obligations of Audax stockholders that signed support agreements and/or letters of transmittal in which they agreed to be subject to the merger agreement's terms, since those Audax stockholders had established privity of contract with Optum, rather than the merger agreement's terms only being binding on them "by operation of law" by virtue of the merger.

Key Takeaways:

  • For transactions with large numbers of target stockholders or other factors that make a merger (rather than stock purchase) structure advisable, the clearest route to imposing enforceable post-closing indemnification obligations on the target stockholders is to require them to sign a support agreement in connection with signing of the merger agreement in which they agree to be subject to the terms and conditions of the merger agreement. The support agreement should specifically reference the signatory target stockholders becoming subject to the post-closing indemnification obligations in the merger agreement by virtue of signing the support agreement.
  • Rather than requiring that only a simple majority of target stockholders sign the support agreement and relying on letters of transmittal or "operation of law" by virtue of the merger to make the post-closing indemnification obligations to the buyer binding on the other target stockholders, consider requiring that a supermajority (67% - 90%) of target stockholders sign the support agreement.
  • Consider utilizing an escrow structure in which part of the merger consideration is placed into a third party escrow to be used as the primary or exclusive means of satisfying the target stockholders' post-closing indemnification obligations to the buyer, rather than relying on "clawback" of merger consideration from the target stockholders.
  • If the amount placed into escrow would not adequately protect the buyer for losses resulting from breaches of the target's representations and warranties, consider obtaining "representations and warranties" insurance to cover any liabilities in excess of the escrow amount.
  • For transactions in which the seller is adverse to putting a significant amount of the merger consideration into escrow, consider a "hybrid" approach in which the amount of the escrow is reduced (potentially to zero) as additional target stockholders become parties to the support agreement after signing of the merger agreement and prior to closing.
  • Rather than providing in the merger agreement that the target stockholders' indemnification obligations for breaches of "fundamental" representations extends "indefinitely" after closing, consider limiting the duration of that indemnification obligation to the 20 year time period under the newly-enacted Chapter 10, Section 8106(c) of the Delaware Code.
  • Consider including an indemnity cap of something less than the full merger consideration received by target stockholders for buyer losses resulting from breaches of "fundamental" representations.
  • Do not include any new substantive obligations in the letter of transmittal, like stockholder claims release provisions, that are not specifically described in the merger agreement.
  • Rather than providing that the letter of transmittal will be "in a form reasonably acceptable to the buyer," attach the form of letter of transmittal as an exhibit to the merger agreement, so that it is clear that the stockholders' approval of the merger agreement includes approval of the letter of transmittal.
  • Consider putting the stockholder claims release provision in the body of the merger agreement or in the support agreement, rather than in the letter of transmittal, or making delivery of signed stockholder claims release agreements, in a form attached as an exhibit to the merger agreement, a closing condition.
  • Ensure that stockholder claims release language is limited to claims made by the stockholder against the target company in its capacity as such, rather than it being a "general" release or otherwise including other matters within the scope of the release.  


1 Cigna Health and Life Insurance Co. v. Audax Health Solutions, Inc., C.A. No. 9405 (Del. Ch. Nov. 26, 2014).

2 The court rejected Cigna's request to invalidate the merger agreement's provisions appointing a stockholder representative to take post-closing actions on behalf of the Audax stockholders, citing insufficient pleading by Cigna on that issue.

3 In re OPENLANE Shareholders Litigation, C.A. No. 6849-VCN (Del. Ch. Sept. 30, 2011).  

4Aveta v. Cavallieri, C.A. No. 5074-VCL (Del. Ch. Sept. 20, 2010).

5 The Cigna court mentioned the Aveta and OPENLANE decisions, but instead relied on the Delaware Chancery Court's earlier decision in Nagy v. Bistricer, 770 A.2d 43 (Del. Ch. Nov. 22, 2010), a "squeeze-out" merger case in which the merger consideration to be received by the minority stockholder was subject to subsequent adjustment by the buyer's board of directors. The Nagy court held that the lack of a "firm" amount of merger consideration by the statutory deadline for making an appraisal claim under Delaware law made it impossible for the minority stockholder to decide whether to exercise his appraisal rights in connection with the merger.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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