What remedy should a target be entitled to get from a breaching buyer in a merger transaction? This seemingly straightforward question has surprisingly vexed M&A practitioners and judges over the years.

With a public target, the buyer typically promises to pay the consideration to the target shareholders (and not the target), often at a premium above the target’s pre-announcement stock price. At the same time, the merger agreement involves the buyer, the target, and the merger sub (the buyer’s wholly owned subsidiary, often created solely for the merger), but not the target shareholders. Not only that, the agreement often expressly stipulates that there are no third-party beneficiaries, including the target shareholders. In case the buyer breaches the merger agreement and the merger fails to close, while the target shareholders are denied the promised consideration from the buyer, it is unclear what the target corporation has suffered, particularly given that the target was meant to continue its operation (with all of its assets) before and after the merger. Furthermore, given that the target shareholders are expressly denied a third-party beneficiary status, it is unlikely that they can pursue a direct claim against the buyer, despite having lost out on the merger premium.

To address this structural and contractual conundrum, since the Second Circuit’s decision in Consolidated Edison v. Northeast Utilities, many M&A practitioners have been contractually stipulating the target’s right to collect the “lost premium” on behalf of the target shareholders. The clause has been colloquially known as the “Con Ed” provision. While the validity of such a clause under Delaware law had remained uncertain, in a recent case, Crispo v. Musk, the Delaware Chancery Court held that the provision is unenforceable. The court reasoned that allowing a disappointed target that has suffered little, if any, harm from the buyer’s breach to nonetheless collect the “lost premium” from the breaching buyer would violate contract law’s anti-penalty doctrine. In response to this decision, the Delaware State Bar Association’s Corporation Law Council proposed to amend the Delaware General Corporation Law, allowing the parties to include a lost premium provision in a merger agreement and also to designate the target corporation as a “representative” of the target shareholders to collect the stipulated damages. In June 2024, Delaware’s Legislature passed the proposed amendment. The amendment subsequently was signed into law by Delaware Governor John Carney in July 2024 and will become effective on August 1, 2024.

In a recent paper, we analyze the impact of the Crispo decision and the subsequent proposal to amend the Delaware General Corporation Law. Following a brief overview of the relevant literature and an introduction to the legal issues, the paper first engages in a hypothesis development with a stylized, theoretical model, which offers several empirical predictions. The theory predicts, for instance, that disallowing monetary damages will generally be harmful to the target that has already entered into a merger agreement. It also predicts that preventing the target from collecting damages from a breaching buyer can potentially lead to too many (inefficient) breaches, thereby reducing overall (expected) surplus from the transaction. This implies that the decision provides an incentive to transacting parties to implement a contractual “fix” to better realize the transactional surplus and to prevent inefficient breaches. Also, without any remedy against breach, the merger premium could be (on average) larger, since the transactions with relatively small surplus will probably not be entered into (or subject to a breach) in the first place. On the other hand, if the transacting parties can neutralize the impact of Crispo using contract provisions, or if the target can more successfully receive specific performance against a breaching buyer, the impact on merger premium would be minimal.

Second, following up on the hypothesis development, the paper examines the stock market reactions to the Crispo decision to determine whether it had any meaningful impact on target companies. At the time of the decision, there were about 49 pending transactions involving public targets, for which we have access to relevant data. Among them, 35 were governed by Delaware law and 14 were governed by non-Delaware law. With this dataset, we utilize the event study methodology to see the stock price reaction of the target companies. The paper finds that, for transactions governed by Delaware law, there was a statistically significant, negative return on the target companies’ stocks. The result is robust to the different windows around the decision with which the abnormal returns are measured. Furthermore, a difference-in-differences analysis shows that Delaware targets had abnormal returns that were significantly smaller than targets in open mergers governed by non-Delaware laws. These findings suggest that the Crispo decision was a negative shock to Delaware targets, and the decision had a meaningful economic impact on affected mergers.

Third, we manually collect relevant provisions from publicly announced and filed merger agreements to determine whether and how contracting practice has been shaped by the Crispo decision and the subsequent amendment proposal. In the aftermath of Crispo, M&A practitioners have suggested several possibilities for restoring the ability of the target (or the target shareholders) to recover the promised premium from a breaching buyer. This exercise can inform us about how M&A practitioners (or commercial contracting parties more broadly) can respond to a legal shock and how contracting practice can converge to a new equilibrium.

Our analysis of the contract terms uncovers a few important patterns. First, we observe an emergence of two new contracting practices in response to the decision: (1) recognizing the shareholders as third-party beneficiaries (in narrow circumstances) while expressly designating the target corporation as the sole entity to sue the buyer to collect the damages; and, in certain cases, (2) designating the target company as its shareholders’ “agent” for recovering the lost merger premia. We observe that, after the decision, especially for Delaware deals, the frequency of such provisions has increased substantially, to about half of the sample agreements. This finding supports the hypothesis that the transactional lawyers (or at least a sizable subset of them) seem to be actively responding to the decision.

On the deal premium side, although the overall merger premia do not seem to exhibit any statistically significant change after the decision, when we divide the sample into those with a non-price contractual “fix” and those without, the deals with a novel contractual term tend to have a lower premium, which is consistent with the theoretical prediction that price and non-price responses to Crispo are substitutable. We acknowledge that both price and non-price terms of a merger agreement are being determined simultaneously, and this leads us to caution against reading too much into the results on merger premia. The overall results, however, indicate that transactional parties seem to have responded robustly to Crispo by changing non-price terms.

This post comes to us from professors Dhruv Aggarwal at Northwestern Pritzker School of Law, Albert H. Choi at University of Michigan Law School, and Geeyoung Min at Michigan State University College of Law. It is based on their recent paper, “Contractual Remedies in Mergers: Lessons from Crispo v. Musk,” available here.