United States: When Do Merger Benefits To Directors Constitute Disabling Conflicts?

Last Updated: November 4 2016
Article by Ethan A. Klingsberg

As the Delaware Supreme Court narrows the avenues for post-closing challenges to mergers (see our discussions of the implications of the Corwin and Cornerstone decisions here, here, here and here), we expect that plaintiffs' lawyers will increasingly seek to base their merger suits on specific allegations of conflicts that may have tainted the oversight of processes to sell companies in hopes of supporting claims for breaches of the duty of loyalty and the applicability of the enhanced scrutiny of the entire fairness doctrine. Given that virtually every merger includes some special merger benefits for directors that may be susceptible to an attempt at such a claim, it is timely that the Delaware Court of Chancery issued a decision over the summer of 2016 that provides useful guidance on how to evaluate the most common of special merger benefits to insiders: protection against exposure to pre-merger claims.

Merger agreements regularly protect the directors and officers of target corporations from pre-merger claims through assurances of indemnification, expense advancement, and insurance coverage. Although these protections constitute a special benefit for these insiders that is not shared with the other stockholders, they are not generally viewed as grounds for claims of disabling conflicts. These merger agreement benefits are typically redundant assurances to comply with pre-existing, ordinary course commitments to these insiders and therefore, except for the incremental outlay for the customary purchase of a six-year D&O tail policy, do not increase costs. Moreover, while the D&O tail policy to cover the outgoing target directors is an incremental transaction cost, the amount is usually immaterial and insufficient to support a claim that this payout somehow diverted money that would otherwise have been allocated in the course of negotiations to the merger consideration to the stockholders. Perhaps most importantly, the deference to a merger agreement's grant of these benefits to a target's directors and officers is grounded in the reasonableness of such protection as a quid pro quo for taking on the high-pressure position of navigating a public company through a sale process. Without the customary granting of these benefits in merger agreements, the attraction of qualified individuals to serve as fiduciaries for public companies contemplating strategic alternatives would be difficult.

Nonetheless, there are scenarios where directors of target corporations should be concerned that obtaining these types of benefits for themselves in a merger agreement creates a disabling conflict for which they may have personal liability. In July 2016, in the case of In re Riverstone National, the Court of Chancery addressed this question of whether a merger agreement's insulation of the target corporation's directors from the risk of pre-merger claims may taint the merger with a problematic conflict. The plaintiff stockholders were suing the target corporation's directors after the closing of the merger for damages based on their adoption of a merger agreement that included a commitment by the acquiror to assure that the target company would not assert potential claims against these directors for usurpation of corporate opportunities prior to the closing. The claim rested on allegations that this protection diminished the value of the target company to the acquiror (since the right to assert successfully these corporate opportunity claims against these directors was an asset that may have resulted in cash proceeds) and therefore had the effect of diverting value to the directors that would otherwise have been allocated to the merger consideration.

Although the Court denied the defendants' motion to dismiss the claim that the inclusion of these provisions in the merger agreement constituted a breach of the directors' duty of loyalty, the Court felt it important to articulate a standard to prevent opening the floodgates to these types of lawsuits. After all, some type of protection of target corporation directors from pre-merger claims is pervasive in merger agreements.

The criteria for a viable claim that directors violated their duties of loyalty based on their adoption of a merger agreement that includes contractual provisions that have the effect of protecting these directors against exposures to pre-merger claims, as explained by the Court, were as follows:

  • The personal benefit to the directors must be real, as opposed to highly contingent. Thus, the potential claim from which the directors are being protected by the merger agreement must not be hypothetical claims, but ones that appear to be claims that would have survived motions to dismiss by the defendant directors;
  • At the time of the negotiation of the merger agreement, the defendant directors benefitting from these merger agreement provisions must be aware of both these imminent exposures to pre-merger claims and the beneficial provisions in the merger agreement; and
  • The potential liability against which these director are being insulated must be of a magnitude that is material to the directors in question.

The Court held that the complaint included specific allegations that satisfied each of these three criteria.

Although these three critera laid out by the Court in Riverstone National will be helpful in guiding boards on what types of protections for directors are acceptable in merger agreements, there is another distinguishing element of the merger agreement provisions at issue in Riverstone National that is worthy of consideration by boards going forward. The claim against which the merger agreement protects these directors is usurpation of a corporate opportunity which constitutes a breach of the duty of loyalty and therefore is a type of claim that is beyond the scope of claims with respect to which corporate law permits a corporation to grant its directors exculpation or indemnification (although Delaware permits advance waivers of corporate opportunities, Riverstone National makes no mention of the possibility of an advance waiver; rather the issue is the attempt at after-the-fact insulation from the claim by virtue of the merger agreement). Although the record is unclear, it appears that the merger agreement attempted to get around this limitation by having a third party, the acquiror, agree to grant this broad protection to the directors. By contrast, the typical merger agreement provides only for the target corporation, or for the acquiror to cause the target corporation, to protect the directors from pre-merger claims. Accordingly, these more typical contractual protections of the target directors, since they are to be implemented by acts of the target corporation rather than the third party acquiror, are subject to the corporate law limitations against a corporation's protecting its own fiduciaries from liability for breaches of the duty of loyalty.

Indeed, when reviewing the CVS/Caremark merger in 2007, the Court expressed dismay with a similar negotiation by a target board of an enhanced version of the typical pre-closing claim protections. The Caremark/CVS merger agreement contained what the Court of Chancery characterized as an attempt at an end-run around the provisions of corporate law that prevent a corporation from indemnifying its own directors and officers for breaches of the duty of loyalty and other failures to act in good faith, as opposed to breaches of the duty of care in the absence of bad faith. If CVS, as the merger acquiror, had simply agreed to cause Caremark to continue to indemnify Caremark's current and former directors and officers after closing for pre-closing claims, then these corporate law limitations would have continued to apply. But the undertaking in the merger agreement required CVS, a third party, to provide a direct indemnity to these directors and officers of Caremark. This creation of a contractual indemnification right from a third party (CVS) would not necessarily be subject to the legal limitations applicable when Caremark is indemnifying its own fiduciaries. This end-run was particularly provocative given the backdrop of pending option-backdating claims against Caremark's insiders that were potentially of the same type that the Court of Chancery had held earlier would, if proven, constitute violations of the duty of loyalty and therefore leave the defendant directors without the benefits of indemnification by their own corporation. Nevertheless, although the Court had nothing but words of concern for these provisions in the CVS-Caremark merger agreement, the case involved solely a motion to enjoin the Caremark stockholders meeting, which the Court refused to do as a result of the adequate disclosure about these troublesome contractual provisions. The CVS/Caremark case thus never reached the question, taken up in Riverstone National this past summer, of whether there had been a breach of the duty of loyalty by the target directors that would support a post-merger damages remedy.

Given the plaintiffs bar's heightened focus on conflicts allegations as a means to overcome motions to dismiss claims against target directors premised on merger agreements, the boards of target corporations, when reviewing the protections they are granting themselves when adopting merger agreements, should pay attention to not only the guidance of Riverstone National, but also the arguable legacy of the CVS/Caremark opinion in the Riverstone National decision.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions