February 23, 2017
On February 8, 2017, U.S. District Judge Amy Berman Jackson blocked the proposed $48 billion merger of health insurers Anthem Inc. and Cigna Corp. on antitrust grounds. In the wake of this ruling, Cigna notified Anthem that it was terminating their merger agreement and, on February 14, filed suit against Anthem in the Delaware Court of Chancery for a declaratory judgment that it had lawfully terminated the agreement. Cigna’s suit seeks recovery of a $1.85 billion reverse termination fee and more than $13 billion in damages that Cigna claims represents the premium value its stockholders lost due to Anthem’s alleged breaches of the merger agreement.
On February 15, 2017, Anthem filed its own suit in the Delaware Court of Chancery seeking, among other things, to enjoin Cigna from terminating the merger agreement and recovery of damages for Cigna’s alleged breaches of the merger agreement. On February 16, 2017, the court entered an order temporarily enjoining Cigna from terminating the merger agreement pending a preliminary injunction hearing.
Important lessons can already be learned from this situation.
The Anthem-Cigna merger agreement provides that Anthem must pay Cigna a $1.85 billion fee—typically referred to as a “reverse termination fee” or “reverse break fee”—if either party terminates the merger agreement because of the failure to obtain antitrust clearance. Reverse termination fees are somewhat common in transactions that involve material antitrust risk.
Under the Anthem-Cigna merger agreement, either party may terminate–and thereby trigger the reverse termination fee–if the transaction has not been consummated by January 31, 2017 (extendable to April 30, 2017 in certain circumstances, such as an antitrust delay). Either party may also terminate at any time–and thereby trigger the reverse termination fee–if a legal order or injunction preventing the consummation of the transaction has become final and non-appealable.
The agreement specifically provides, however, that a party may not terminate if it breaches its contractual obligations in any manner that “proximately caused or resulted in the failure of” the transaction to be consummated. This type of provision is fairly common. As evidenced by the competing suits between Anthem and Cigna, however, such a provision can inject meaningful uncertainty as to whether a party is actually permitted to terminate a merger agreement because it conditions the right to terminate on a party’s compliance with the agreement’s covenants.
Whether a party has complied with its covenants may be a simple question (e.g., has a party made its HSR antitrust filing?). Or, it may be a very complex question (e.g., has a party used its reasonable best efforts to negotiate with the antitrust authorities and convince them that the deal presents no competitive harm?). And the answer to the question may hinge on information that is confidential and not known to the respective merger partners (e.g., how does Cigna know that Anthem tried hard to get antitrust approval? And vice versa?).
The result of this complexity and uncertainty is litigation–an outcome that is undesirable to all involved.
Breakup fees, termination fees, reverse breakup fees, reverse termination fees, closing failure fees, financing failure fees – etc., etc., – are concepts that are easily misunderstood. This confusion stems, in part, because these fees take a wide range of forms and serve a wide range of functions.
For example, the traditional “breakup fee” included in a public company merger agreement is merely a deal protection device. It is designed to protect the deal from a third party interloper who seeks to break up the transaction. It is not designed to allocate risk between the merger parties, and it is typically payable in circumstances in which there has been no breach of the merger agreement. In other words, it is not designed to compensate one party because the other party has breached.
On the other hand, the traditional private equity style “reverse termination fee” (aka, a “financing failure fee”) is usually constructed as a fee payable upon breach of the merger agreement. This fee is designed to allocate risk between the parties – specifically, the risk of whether or not financing for the transaction will be obtained. If the fee is payable, it is typically described as liquidated damages, and designed to compensate the target company because the buyer has breached by failing to close the deal. It is also usually described as the target company’s “sole remedy” for the buyer’s inability to obtain financing. In other words, if the buyer does not obtain financing, then the only thing the target can do is take the reverse termination fee. The target is typically not permitted to sue for damages above and beyond the fee.
The reverse termination fee in the Anthem-Cigna merger agreement is a hybrid of the above. Like the private equity style reverse termination fee for financing failure, it is designed to allocate risk (in this case, antitrust risk) between the parties. But like the traditional public company style breakup fee, it is payable in circumstances in which there has not been a breach of the merger agreement.
Plus, under the Anthem-Cigna merger agreement, the reverse termination fee is not Cigna’s sole remedy if Anthem has breached the agreement. The agreement states that “if Cigna receives the Reverse Termination Fee…and Anthem has not Willfully Breached any of its obligations under this Agreement, such payment shall be the sole and exclusive remedy of Cigna against Anthem…” (emphasis added).
Thus, the merger agreement seems to specifically contemplate the scenario where Anthem has paid the $1.85 billion fee, and on top of that fee could owe Cigna additional damages. Anthem may try to argue, however, that the reverse termination fee is intended to be liquidated damages, and that Cigna is not entitled to additional damages above and beyond the fee. If Anthem were to advance such an argument, Cigna would likely argue that the purpose of the fee was solely to allocate antitrust risk in a non-breach scenario and that, if Anthem willfully breached, Cigna can recover its full damages regardless of whether or not the fee is paid.
Although the phrase “willful breach” would seem to have an obvious meaning, it is subject to competing interpretations. Does “willful” mean that the breaching party has to intentionally perform the act which results in a breach? Or does “willful” mean that the breaching party has to take an action that it knows will breach the agreement?
In Hexion Specialty Chemicals, Inc. v. Huntsman Corp., C.A. No. 3841 (VCL) (Del. Ch. Sept. 29, 2008), Vice Chancellor Stephen P. Lamb stated that a “knowing and intentional” breach of a merger agreement is “a breach that is a direct consequence of a deliberate act undertaken by the breaching party,” and did not require that the breaching party act “purposely with the conscious object of breaching the agreement.”
The Anthem-Cigna merger agreement specifically defines a “Willful Breach” as “a material breach of [the merger agreement] that is the consequence of an act or omission by a party with the actual knowledge that the taking of such act or failure to take such action would be a material breach of [the merger agreement.]” In other words, the breaching party had to know that its action or inaction would constitute a breach. An action or inaction that inadvertently resulted in a breach would not be a “Willful Breach”.
This standard–which differs from the default Hexion rule–obviously favors Anthem in defending Cigna’s claims for $13 billion in damages, as Cigna will have to show that Anthem engaged in activity that Anthem knew would be a material breach of the merger agreement. However, the merger agreement also provides Cigna will not be entitled to receive the fee if the failure to obtain the required regulatory approvals was caused by Cigna’s “Willful Breach”. Thus, this heightened standard cuts in both directions in that it will also make it more difficult for Anthem to prove that Cigna is not entitled to the reverse termination fee as a result of its alleged willful breaches.
Although this matter is still in its early stages, there are some initial lessons that can be gleaned:
1) Exceptions to a termination fee for “willful breach” can easily lead to litigation, regardless of how “willful breach” is defined. This diminishes the utility of the termination fee, which is often included to minimize the possibility of litigation.
2) If a willful breach exception is included, it is a good idea to include a specific definition of willful breach.
3) If a willful breach exception is included, consider adding provisions that encourage the parties to take the termination fee, rather than suing for damages. For example, consider providing that (a) a party is not entitled to recover both the termination fee and also damages on top of the fee, (b) if a party sues for damages, that party cannot later recover the termination fee if its lawsuit is unsuccessful, and (c) the loser pays the winner’s legal fees in any suit for damages.
4) Provisions that condition a party’s right to terminate on that party’s compliance with its covenants can inject significant uncertainty as to whether or not a party actually has the right to terminate. Thus, consider whether it is preferable to allow the parties to terminate (even if in breach), and then sue each other for damages post termination. Such a construct would not avoid litigation, but would avoid the uncertainty as to whether or not the parties were still obligated to complete the transaction.
The following Gibson Dunn lawyers assisted in preparing this client update: Jonathan Corsico, Aric Wu and Quinton Farrar.
Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues. For further information, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s Mergers and Acquisitions practice group:
Mergers and Acquisitions Group / Corporate Transactions:
Barbara L. Becker – Co-Chair, New York (212-351-4062, [email protected])
Jeffrey A. Chapman – Co-Chair, Dallas (214-698-3120, [email protected])
Stephen I. Glover – Co-Chair, Washington, D.C. (202-955-8593, [email protected])
Dennis J. Friedman – New York (212-351-3900, [email protected])
Jonathan Corsico – Washington, D.C. (202-887-3652), [email protected]
Mergers and Acquisitions Group / Litigation:
Meryl L. Young – Orange County (949-451-4229, [email protected])
Jason J. Mendro – Washington, D.C. (202-887-3726, [email protected])
Aric H. Wu – New York (212-351-3820, [email protected])
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