Merger Agreements, Termination Fees, and the Contract-Corporate Tension

Tuesday, January 1st, 2002 at 12:00 am by Judd F. Sneirson
Judd F. Sneirson, Merger Agreements, Termination Fees, and the Contract-Corporate Tension, 2002 Colum. Bus. L. Rev. 573

Merger agreements are complicated contracts. They effectuate the combination of business entities that themselves can be complicated structures. Moreover, where one of the merging entities is incorporated, as is often the case, there is the additional complication that the persons negotiating and entering into the agreements are fiduciaries acting on behalf of, and owing fiduciary duties to, the corporation and its shareholders. This additional dimension, not present in a simple two-party contract, implicates the law of fiduciaries and provides a second, entirely separate analytical framework, in addition to contract law, by which to assess a transaction.

This dual view of merger agreements–that they implicate both contract and corporate law–is nothing new. So it should come as no surprise when a court judges a merger agreement according to the conventional contract law principles. Yet, in the 1997 case of Brazen v. Bell Atlantic Corporation, where the Delaware Supreme Court did just that, the legal community was taken aback. Accustomed to corporate law standards exclusively governing corporate law issues, the bar and commentators did not quite know what to make of the Delaware Supreme Court’s contract law analysis of the Bell Atlantic-NYNEX merger agreement. Indeed, many dismissed the case as sui generis, while others took it to mean simply, if incorrectly, that if merger partners couch their agreement in contract terms, it will be analyzed according to those (contract law) standards; if they do not, it will not, and corporate law’s panoply of standards of review would instead apply.

Termination fees in merger agreements, like the one at issue in Brazen, provide a useful vehicle for exploring this contract-corporate overlap further. Termination fees are contractual provisions requiring one would-be merger partner to pay the other some stipulated amount in the event their deal falls through. They are routine in merger agreements and, when shareholders or competing bidders challenge them as being excessive, the fees are analyzed according to whatever fiduciary duties are implicated. But termination fees are also unmistakably contractual liquidated damage provisions–commonplace provisions that require a breaching party to pay the injured party some stipulated amount when triggered. Each body of law has its own way of analyzing termination fees, and for the most part the two do not conflict. But sometimes they do, and in those instances contract and corporate law must be sensibly reconciled.

Such a sensible reconciliation has yet to be accomplished, however. A review of Delaware case law produces only a handful of decisions addressing this contract-corporate tension, and those cases offer surprisingly little analysis and suggest wildly varying resolutions. Furthermore, the approaches that can be gleaned from these decisions have not previously been explored in any detail. Moreover, to the extent subsequent cases and commentary have touched on these approaches, courts and commentators have viewed them from a predominantly corporate law perspective, without due regard for contract law principles and interests that should, at a minimum, inform a consideration of any agreement’s enforceability.

This Article seeks to correct these oversights. Part II of this Article describes termination fees, explains how they relate to similar merger agreement provisions designed to protect transactions, and explains how and why termination fees operate. Part III sets out the ways in which corporate and contract law approach termination fees, and then sketches out four possible permutations of combinations in which termination fees pass muster, or not, under each of corporate and contract law. One of these, of course, is where corporate and contract law conflict. After setting forth the interests that a sensible resolution of this conflict should address, Part IV presents and explores the different possible approaches to resolve the tension. Part IV then assesses each approach in light of the contract and corporate interests to be satisfied, and recommends a resolution to the contract- corporate tension that best takes each discipline’s interests into account.

Author Information

Visiting Assistant Professor, University of Oregon School of Law