In private company acquisitions, it is common for the buyer to require that a portion of the merger consideration be set aside in escrow as an accessible source of funds to cover the buyer’s post-closing indemnification claims relating to breaches of the target company’s representations and warranties and other specified contingencies. However, the buyer might demand additional protection if its losses under such claims exceed the escrow amount by insisting upon collection of the full loss from the target company’s stockholders. If the losses are significant and the indemnification obligations are uncapped or have a sufficiently high cap, this could require the target company’s stockholders to return their full pro rata share of the merger consideration to the buyer.
Although the Delaware courts have previously upheld post-closing purchase price adjustments, a recent decision found common provisions unenforceable in certain circumstances. Cigna Health and Life Insurance Co. v. Audax Health Solutions, Inc., C.A. No. 9405 (Del. Ch. Nov. 26, 2014) (V.C. Noble). In this case, the merger agreement and related Letter of Transmittal (the “LoT”) required the target company’s stockholders (1) to indemnify the buyer, up to their pro rata share of the merger consideration, for the target company’s breaches of its representations and warranties, and (2) to release the buyer and its affiliates from any and all claims relating to the merger. The Court found these common provisions unenforceable under the facts in Cigna; accordingly, this decision has significant implications for other private company acquisitions by merger.