Delaware courts have historically applied a contractarian approach, focusing primarily on the four corners of the document when interpreting and analyzing agreements. However, with the recent decision in Thompson Street Capital Partners IV, L.P. v. Sonova U.S. Hearing Instrument LLC, Delaware courts could be shifting away from this tried and true approach.
Thompson Street Capital involved a dispute between two parties to a merger concerning the sufficiency and timeliness of a claims notice sent to the seller before the end of the survival period. Upon expiration of the survival period, the indemnity escrow fund, which was the buyer's sole recourse for any rights of indemnification, was to be released to the seller. In its complaint, the seller alleged that the claims notice (a) failed to include the "specificity" regarding the claim as required by the merger agreement and (b) was untimely because it was not sent within 30 days after the buyer became aware of the issue as required by the merger agreement.
Initially, the Court of Chancery granted the buyer's motion to dismiss, finding that the language was ambiguous and that the seller failed to plead a claim for relief. In reaching its decision, the Court of Chancery measured the timing and sufficiency of the claims notice against the provisions of the escrow agreement, which were contractually integrated into the merger agreement. The seller then appealed to the Delaware Supreme Court (the "Court").
On appeal, the seller asserted that the lower court erred in focusing primarily on the terms of the escrow agreement. The buyer, alternatively, maintained that the escrow agreement properly governs the release of indemnity escrow funds and that compliance with the notice provisions in the merger agreement was not a condition precedent to the buyer's ability to obtain relief.
Ultimately, the Court found that the Court of Chancery did not adequately focus on the merger agreement's notice requirements, and that the buyer's compliance with the notice provisions was a condition precedent to its ability to obtain indemnification relief. In reaching these conclusions, the Court focused on the plain meaning of the language in the merger agreement and typical principles of contract interpretation. Thus, while the Court's analysis did feature elements of the contractarian approach Delaware courts are known for, the Court ultimately remanded the case back to the Court of Chancery, and in doing so, introduced equitable principles at odds with this typical approach.
The first indication of the Court's break with Delaware-style contractarianism came in the first sentence of the opinion: "Delaware is a contractarian state, but our common law abhors a forfeiture." After determining that the buyer's compliance with the notice provisions in the merger agreement was clearly a condition precedent to the buyer's ability to obtain relief, the Court went on to explain that "the non-occurrence of a condition precedent may be capable of triggering a forfeiture," or a deprivation of rights or property, a concept that Delaware common law strongly disfavors.
This "tension", as the Court put it, caused the Court's analysis to shift towards considering whether the resulting forfeiture would be disproportionate and whether the occurrence of the condition precedent was a material part of the agreed-upon bargain. The Court, citing the Second Restatement of Contracts, reasoned that it "may excuse the nonoccurrence of a condition that would cause a disproportionate forfeiture unless its occurrence was a material part of the agreed Exchange." The opinion went on to provide a list of considerations that would factor into the "disproportionate" and "materiality" decisions, such as the extent of the possible injury of the party suffering the forfeiture, whether the behavior of the party failing to perform complied with principles of good faith and fair dealing, and whether the party suffering the forfeiture could otherwise be made whole. The Court remanded the case back to the Court of Chancery to further develop the facts needed to reach a decision on the "disproportionate" and "materiality" concepts.
While this dispute is still ongoing, the Court's willingness to allow equitable considerations to deviate from the outcome plainly contemplated by the merger agreement is a departure from the typical style Delaware courts are known for.
The Impact
The Thompson Street Capital decision has the potential to significantly reshape M&A negotiations and transactions. Under this ruling, a seller can no longer rely solely on proving that a buyer's claim notice was deficient under the merger agreement; the seller must also show that the notice requirements, such as timing and specificity, were material to the agreement. This additional burden could make Delaware less attractive as the chosen governing law in future deals.
For sell-side counsel, the decision emphasizes the importance of drafting indemnification, survival, and notice provisions with precision. Agreements should expressly identify which conditions are intended to be material and which are true conditions precedent to recovery. Without this clarity, courts may be reluctant to enforce technical notice requirements if the enforcement would result in unfair forfeiture.
From the buyer's perspective, there is less risk of losing indemnification rights due to minor procedural missteps. This dynamic strengthens the buyers' leverage in post-closing negotiations and may increase the pursuit of indemnity claims, particularly where underlying damages are substantial and notice defects are merely technical.
In conclusion, the Court's ruling has broad implications for how risk is allocated in M&A transactions. While Delaware remains the leading forum for deal litigation, this case is a reminder that contracting parties must expressly state which provisions are intended as strict conditions precedent. Without that specificity, courts may balance contract language against equitable considerations to prevent forfeiture.
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