Delaware Court of Chancery Strictly Construes Shareholder Representative Provision, Complicating Discovery from Shareholders
Following a recent Delaware case, buyers in M&A deals should ensure that their purchase agreements adequately provide for access to information from the seller in case of post-closing disputes.
In Fortis Advisors, LLC v. Allergan W.C. Holding, Inc., Vice Chancellor Morgan Zurn ruled that if a buyer consents to a single shareholder representative structure in a merger agreement, the buyer cannot later compel the individual selling shareholders’ participation in discovery as parties in interest.[1] The Fortis decision arose out of Defendant Allergen’s merger with Oculeve, Inc. and a dispute over selling shareholders’ entitlement to a post-closing milestone payment under the merger agreement. When Allergan declined to pay the milestone payment to the former Oculeve shareholders, Plaintiff Fortis Advisors LLC alleged that Allergen had materially breached the merger agreement. Thereafter, Allergan served an initial document request that sought information from over fifty individual non-party selling shareholders.
The merger agreement appointed Fortis to act as the shareholders’ “sole, exclusive, true and lawful agent, representative and attorney-in-fact” with respect to “any and all matters relating to, arising out of, or in connection with” the Agreement.[2] Fortis objected to the document requests on the basis that they were directed to the “Sellers,” who were not parties to the litigation. Allergan then filed a motion to compel the selling shareholders to participate in discovery as parties-in-interest, and in the alternative sought to compel Fortis to procure documents and testimony from the shareholders as their representative.
The Court was “reluctant to disregard the clear contractual authority of the Stockholders’ Representatives at the behest of [Allergen].”[3] Like many jurisdictions, Delaware courts enforce the negotiated language of the parties’ agreement, especially when those parties are “sophisticated entities that are engaged in arms-length transactions.”[4] Accordingly, the Court ruled that the contractual language appointing Fortis as the shareholders’ “sole, exclusive, true and lawful agent,” including for matters regarding “contingent payments,” made Fortis the real party in interest.[5] Moreover, the Court concluded that the merger agreement did not empower Fortis to compel the shareholders to participate in litigation, because the agreement did not grant Fortis “control” (within the meaning Del. Ch. Ct. R. 34[6]) over the shareholders or their documents.
Lastly, the Court pointed out that Allergan had desired structural efficiency in closing the merger and in adjudicating post-closing disputes when it agreed to a shareholder-representative model; thus, “the fact that the Merger Agreement does not give Fortis control over the Stockholders and their discovery is not Fortis’s ‘fault’ or ‘problem’—it is the result that Allergan bargained for.”[7] The Court denied Allergan’s motion, noting that the information that Allergen sought could still be obtained through third-party discovery.
The purpose of appointing a shareholder representative is to allow both buyers and sellers in M&A deals to resolve post-closing disputes efficiently. Individual shareholders may not wish to undertake the risk of becoming a named defendant in a post-closing dispute, or may not have the resources or expertise to successfully navigate post-closing matters. Shareholder representatives can shoulder both burdens. Additionally, buyers can uniquely benefit from a representative structure because any judgment against the shareholder representative is binding on all shareholders, eliminating the risk of inconsistent judgments.
However, Fortis is another example of the Delaware courts’ deference to the specific language within an agreement, providing a warning that shareholder representative clauses cannot be “retrofitted” to meet one of the parties’ needs after litigation has begun. Buyers should carefully consider the parties’ responsibilities post-closing and negotiate for appropriate discovery rights.
Although Vice Chancellor Zurn noted that Allergen could obtain the requested information through third-party discovery, Buyers should be aware that third-party discovery can lead to numerous practical challenges and greater expense. In this case, the third-party discovery process would require Allergen to serve a subpoena to each of the 50-plus selling shareholders. Subpoena requirements vary by state and if the subpoena is contested, additional time and resources must be spent to resolve the dispute.
To avoid these complications, buyers can include contractual provisions requiring selling shareholders to comply with reasonable document requests and empower the shareholder representative to obtain relevant information from the selling shareholders.
[1] 2020 Del. Ch. LEXIS 181 (Del. Ch. May 14, 2020).
[2] Id. at *2.
[3] Id. at *6.
[4] Id. at *5.
[5] Id.
[6] “In the Rule 34 context, [c]ontrol has been defined to include ‘the legal right to obtain the documents requested upon demand.” Deephaven Risk Arb Trading Ltd. v. UnitedGlobalCom, Inc., 2005 WL 1713067, at *11
(Del. Ch. July 13, 2005) (quoting 7 James Wm. Moore et al., Moore’s Federal Practice § 34.14[2][b] (3d ed. 2005)).
[7] Id. at *9-10.
