Are “lost-premium” provisions – clauses that typically allow a target to recoup the premium its shareholders were denied because a buyer wrongfully backed out of a deal – enforceable? In a surprising decision last year, the Delaware Court of Chancery said they were not. We argue in a new article, however, that they are both doctrinally defensible and economically sensible.[1]
The Chancery Court’s ruling in Crispo v. Musk (“Crispo”)[2] held that lost-premium provisions cannot be enforced by corporate targets because only shareholders – who are not party to an M&A contract – and not the target company may expect to receive and therefore have a right to claim the lost premium. In the wake of Crispo, the share prices of targets in ongoing deals dropped,[3] and commentators criticized the removal of this form of shareholder protection. The Delaware General Assembly then amended the Delaware General Corporation Law (DGCL) to restore the legality of lost-premium provisions as of August 1, 2024.
Contrary to Crispo, we argue in our article not only that lost-premium provisions should be legal, but also that courts in states that do not have statutory provisions confirming their legality have a credible way to uphold them.
Crispo and Delaware’s New Legal Landscape
Crispo came before the Delaware Chancery Court following an unsuccessful class action claim by a Twitter shareholder, Luigi Crispo (Plaintiff), against Elon Musk and his affiliated companies (Defendants).[4] After Musk’s acquisition of Twitter (now X) closed in October 2022, the plaintiff initiated a petition for mootness fees on the basis that his earlier lawsuit helped cause the acquisition to close and therefore constituted a corporate benefit to Twitter. To apply the conventional mootness-fee tests and determine whether the plaintiff had a meritorious claim at filing as a third-party beneficiary, the Chancery Court considered the lost-premium provision in the Twitter-Musk merger agreement.[5] The court found that the agreement did not provide the plaintiff with standing at the time the lawsuit was filed. While this conclusion was sufficient to dispose of the issue, the court went on to consider the legality of lost-premium provisions more generally. It held that they are illegal penalty clauses because the target does not expect to receive the premium and therefore has no legal interest in it.[6]
Following criticism from M&A practitioners and legal commentators,[7] the Delaware General Assembly amended Section 261 of the DGCL to restore the legality of lost-premium provisions. The new section allows a target to retain lost shareholder premium damages, thereby enabling parties to contract around Crispo’s interpretation of these provisions. New Section 261(a)(2) also enables another type of lost-premium provision by allowing shareholders to make an “irrevocable and binding” appointment of a representative with “sole and exclusive authority to take action on behalf of such stockholders” by, for example, enforcing a merger agreement, pursuing a settlement, or seeking lost-premium damages as third-party beneficiaries.[8] While the amended Section 261 is a laudable development for Delaware, lost-premium provisions may of course still be challenged in other jurisdictions.
Doctrine and Policy Support Lost-Premium Damages
We suggest that allowing a target to recover lost premiums is supported by both doctrinal principles and policy considerations. The anti-penalty doctrine is not as strict as Crispo suggests. Contract law generally respects the parties’ self-determination, and it is common for contracting parties to define damages based on certain formulas, which can be enforceable even if they are not a precise measure of incurred losses. The Restatement (First) of Contracts, which Crispo refers to in part, suggests that an agreed upon measure of damages must be “grossly disproportionate” before it becomes unenforceable,[9] while a leading treatise defines such a measure as unenforceable when it is “unconscionable.”[10] It is not clear why receiving a bargained for premium would be an unconscionable amount of damages, particularly given the often balanced bargaining power and sophistication of parties in M&A transactions. Indeed, targets are allowed to bargain for large merger termination fees that are payable to them directly. Twitter, for example, negotiated a $1 billion termination fee for its benefit.[11]
Lost premiums can also be an appropriate measure of a target’s own damages. In the case of a breach of contract by the prospective purchaser, the target does lose the benefit of its bargain for negotiating a change in control. A target corporation expects to receive consideration for doing the deal, particularly in cash-out transactions, where the target’s singular goal in negotiating a merger agreement is to get the best possible deal for shareholders. In cash-out transactions, the target and its shareholders’ interests are aligned or even identical. The target’s loss is best assessed by its shareholders’ loss, since the consideration payable most accurately represents the value and substance of the target corporation’s bargain.
This interpretation is also sensible in policy terms because there is no other equally reliable means of calculating a target’s damages in a busted deal. If not lost premiums, should courts award (in contexts where specific performance is not available) lost synergies, lost cash flows, or another speculative measure? Awarding lost-premium damages is also most consistent with other forms of M&A structures, such as asset sales, where a target may claim the full benefit of the bargain, including a change of control premium.
Conclusion
Lost-premium provisions allow a target corporation to claim damages that include the lost premium or economic entitlements that its stockholders would have received had the deal closed. Although Delaware Chancery held these provisions unenforceable if claims are brought by target companies, we argue that they are doctrinally defensible and economically sensible. While the Delaware legislature’s amendments have, at least for now, settled the issue, it may emerge in other jurisdictions. Should this occur, we suggest that courts in states without similar statutory provisions have a credible way of upholding lost-premium provisions.
ENDNOTES
[1] Lost-premium provisions are also known as “Con Ed” provisions because practitioners began to use them following the decision in Consolidated Edison Inc v. Northeast Utilities, 426 F.3d 524 (2nd Cir. 2005).
[2] 304 A.3d 567 (Del. Ch. 2023).
[3] Dhruv Aggarwal et al., Contractual Remedies in Mergers: Lessons from Crispo v. Musk 3 (Apr. 2024).
[4] X Holdings I, Inc. and X Holdings II, Inc.
[5] This provision stated that termination would not relieve the Defendants from liability for damages in the case of knowing and intentional breach, which “would include the benefits of the transactions contemplated by this Agreement lost by the Company’s stockholders […] taking into consideration all relevant matters, including lost stockholder premium […].” Agreement and Plan of Merger (April 25, 2022), Section 8.2, https://perma.cc/2N4U-E48Z (emphasis supplied).
[6] Crispo, 304 A.3d at 582–84.
[7] See, e.g., Dhruv Aggarwal et al., Contractual Remedies in Mergers: Lessons from Crispo v. Musk (Apr. 2024).
[8] 8 D.G.C.L. § 261 (2024) https://delcode.delaware.gov/title8/c001/sc09/index.html#261.
[9] Restatement (First) of Contracts § 339 cmt. g.
[10] Williston on Contracts § 65:1 (4th ed., May 2024 update).
[11] Agreement and Plan of Merger (April 25, 2022), Item 1.01. Entry into a Material Definitive Agreement, https://perma.cc/2N4U-E48Z.
This post comes to us from Jonathan Chan, an assistant professor at McGill University’s Faculty of Law, and Martin Petrin, the Dancap Private Equity Chair in Corporate Governance at the University of Western Ontario Faculty of Law and DAN Department of Management & Organizational Studies. It is based on their recent article, “Lost-Premium Damages in M&A: Delaware’s New Legal Landscape,” forthcoming in the Yale Journal on Regulation Bulletin and available here.