COURT OF CHANCERY FINDS NO BUYER DUTY TO MAXIMIZE CONTINGENT SALE CONSIDERATION OWED TO SELLER
By Scott E. Waxman and Thomas F. Meyer
In Glidepath Ltd. v. Beumer Corp., C.A. No. 12220-VCL (Del. Ch. February 21, 2019), the Delaware Court of Chancery held that the buyer of a company did not breach transaction documents or violate the implied covenant of good faith and fair dealing in maximizing the long-term value of the company at the expense of short-term profits that would have resulted in greater contingent consideration being paid to the seller plaintiffs (the “Sellers”).
Glidepath LLC (the “Company”) installs baggage-handling systems at airports in the United States. The Company’s financial struggles hindered its ability to secure contracts due to the need to supply bonds in connection with bids. Defendant Beumer Corporation (the “Buyer”) also installs baggage-handling systems, and offered to purchase the Company as a means of expanding its American footprint, believing that, with the Buyer’s financial backing, the Company would be able to compete for larger contracts.
In 2013, the parties reached an agreement in principle on a sale of the Company. Due to disagreements regarding the Company’s valuation, the majority of the purchase price took the form of contingent payments (the “Contingent Compensation”), including an earn-out payment based on the Company’s performance during a three-year period (the “Earn Out Period”). The transaction documents included an operating agreement that governed the affairs of the Company (the “Operating Agreement”).
Soon after the deal closed, the Buyer reoriented the Company towards larger projects that offered higher profit margins, but would not generate the maximum Contingent Consideration. By November 2014, the Buyer determined that the Company was unlikely to produce enough profits for the Sellers to receive any Contingent Consideration.
After learning that no Contingent Consideration would be paid, the Sellers brought claims asserting that the Buyer operated the Company in a manner that (i) breached the express terms of the Operating Agreement, (ii) violated the implied covenant of good faith and fair dealing, and (iii) constituted a breach of fiduciary duties. As damages, the Sellers sought the full value of the Contingent Consideration.
The Court rejected the Sellers’ claims that the Buyer breached the express terms of the Operating Agreement. The Sellers claimed that the Buyer failed to adhere to the Operating Agreement’s requirement that the Buyer support the Company by way of its bonding line. The Court noted that the Buyer did not have its own bonding line until well into the Earn Out Period. Until it secured its own line, the Buyer obtained bonds through its parent company, and the Operating Agreement did not obligate the parent to provide bonding. The Sellers claimed that the Buyer breached a recital in the Operating Agreement that required the Buyer to contribute its “skills, expertise, collateral and interests” to the Company. The Court denied the Sellers’ attempt to “convert the recital into an efforts clause,” noting that recitals do not establish substantive obligations. In its third breach claim, the Sellers claimed that the Company’s manager deviated from the business plan developed during the Company sale negotiations (the “Initial Plan”), which led to a failure to generate financial results necessary to yield the Contingent Consideration. The Court rejected this claim, noting that the Operating Agreement provided that the Company’s manager prepare a business plan on an annual basis, and required compliance with the annual business plan, not the Initial Plan.
Next, the Court rejected the Sellers’ claim that the Buyer violated the implied covenant of good faith and fair dealing by “taking action designed to frustrate the Sellers’ ability to receive the Contingent Consideration.” The Court noted that the implied covenant is best understood as a way of implying terms in an agreement to fill gaps in the agreement’s express provisions, and that the Sellers had not identified any gaps.
The Sellers also claimed that the Buyer breached its fiduciary duties. The Court agreed that the Buyer owed fiduciary duties, but held that those duties did not include an obligation to ensure that the Sellers received the Contingent Consideration. The Court found that the Buyer and its representative satisfied their fiduciary duty of loyalty, by acting in the best interests of their beneficiaries, and duty of care, by making decisions prudently and carefully. Fiduciary principles do not require that fiduciaries maximize the value of contractual claims. The Sellers had to rely on their contract rights and were not entitled to fiduciary protection.
The Court acknowledged that the Contingent Consideration obligations created a conflict of interest for the Buyer. By depressing the Company’s performance during the Earn Out Period, the Buyer could minimize the Contingent Consideration and benefit itself. Under Delaware law, a court applies the stringent “entire fairness” standard of care when analyzing conflicts of interest that might undermine a fiduciary’s ability to make disinterested and independent decisions. Under this test, the Buyer’s course of action in maximizing the long-term value of the Company needed to be objectively fair. The Buyer proved that it acted fairly by focusing on large-scale projects that maximized the value of the Company over the long term.
The Sellers also sought remedies for three breaches of contract that they established through a prior motion for summary judgment. The summary judgment order ruled that the Buyer made unauthorized loans to the Company and failed to prepare audited financial statements, each in violation of the Operating Agreement. The Court found no causal connection between these breaches and the underperformance of the Company’s business. Because the Sellers were unable to prove actual harm from these breaches, the Court awarded nominal damages. The Sellers also established a breach of contract due to the Buyer’s failure to pay amounts to the Sellers equal to the Company’s bank balance at specified dates, which was part of the Contingent Consideration agreed to between the parties. Because the Buyer failed to pay these amounts, the Buyer was obligated to pay the amounts with pre- and post- judgment interest.
Finally, the Court rejected the Sellers’ claim that the Buyer breached a non-competition provision in the Operating Agreement by doing business in Canada, noting that the provision applied to the Sellers, not the Buyer.