Delaware Court of Chancery Applies Implied Covenant of Good Faith and Fair Dealing to Prohibit An Acquiring Entity From Diverting Revenues to Depress Payouts Under a Contingent Purchase Price Provision

In American Capital Acquisition Partners, LLC v. LPL Holdings, Inc., CA NO. 9490-VCG, 2014 WL 354496 (Del. Ch. Feb. 3, 2014), the Delaware Court of Chancery applied the implied covenant of good faith and fair dealing to a merger agreement’s contingent purchase price provision.  The court held that under the implied covenant an acquiring entity must refrain from diverting revenue streams from its subsidiary post-merger in a manner that would depress the payment under the contingent purchase price provision.  The court also held, however, that the implied covenant did not require an acquiring entity actively to maximize revenue streams absent the inclusion of a best efforts provision in the merger agreement.  American Capital Acquisition Partners defines the contours of the implied covenant of good faith and fair dealing as applied to an acquiring entity’s actions affecting the application of a contingent purchase price provision in a merger agreement.

Plaintiff American Capital Acquisition Partners, LLC (“ACAP”) is a New Jersey LLC and the former parent of Concord Capital Partners, Inc. (“Concord”), a provider of investment management solutions.  Individual plaintiffs are the former officers and directors of Concord.  Defendant LPL Financial LLC (“LPL Financial”) is a wholly-owned subsidiary of defendant LPL Holdings, Inc. (“LPL”), a provider of investment advisory services.  ACAP and LPL entered into a Stock Purchase Agreement (“SPA”) whereby LPL acquired 100% of Concord, which became Concord-LPL.  The SPA included a “contingent purchase price provision” under which LPL was obligated to pay additional compensation if LPL-Concord met certain revenue targets.  The individual plaintiffs also entered into supplemental employment agreements with LPL-Concord, and the employment agreements contained a provision for additional compensation as well.

Plaintiffs alleged that defendants misrepresented that LPL Financial had, or would obtain, the technological ability to allow Concord-LPL to meet the revenue targets outlined in the SPA’s contingent purchase price provision and the supplemental employment agreements, when, in fact, LPL Financial did not have the capability, or the intent, to implement the necessary technologies.  Additionally, plaintiffs alleged that LPL Financial conspired to divert clients, personnel and opportunities from LPL-Concord to a subsidiary of LPL, denying Concord-LPL the opportunity to meet its revenue targets, and thus rendering the potential for contingent payments (under both the SPA’s contingent purchase price provision and the supplemental employment agreements) illusory.  Plaintiffs sued defendants for breach of contract, breach of the implied covenant of good faith and fair dealing, fraudulent inducement, equitable fraud and civil conspiracy.  Defendants moved to dismiss the complaint in its entirety.

The court granted in part and denied in part defendants’ motion to dismiss.  The court granted defendants’ motion as to plaintiff’s claim that the defendants breached the implied covenant of good faith and fair dealing by not making technological changes allegedly necessary to allow Concord-LPL to meet the revenue targets set forth in the SPA’s contingent purchase price provision.  The court held that although the parties anticipated that technological changes would be necessary if Concord-LPL was to reach said targets, plaintiffs had simply “failed to negotiate for a best efforts provision” and could not invoke the implied covenant to “write into their agreements an additional term for which they failed to bargain.”

The court, though, denied defendants’ motion as to plaintiffs’ claim that the defendants breached the implied covenant by “pivoting” sales from Concord-LPL to a subsidiary of LPL in order to evade their obligation to pay plaintiffs additional compensation.  The court held that “had the parties contemplated that the Defendants might affirmatively gut Concord-LPL to minimize payments under the SPA and employment agreements, the parties would have contracted to prevent LPL from shifting revenue from Concord-LPL” to LPL’s subsidiary.  The court went on to deny defendants’ motion to dismiss plaintiffs’ breach of contract but grant defendants’ motion as to the three remaining fraud-related counts.

American Capital Acquisition Partners may be read to hold that while the implied covenant of good faith and fair dealing bars an acquirer from actively depressing a contingent purchase price payment, it does not require an acquirer to maximize a contingent purchase price payment.  If a seller wishes to impose an obligation on an acquirer to maximize a contingent purchase price payment, he will need to negotiate for a “best efforts”-type clause as part of the merger agreement.

Source: http://www.corporatesecuritieslawblog.com/2014/02/delaware-court-of-chancery-applies-implied-covenant-of-good-faith-and-fair-dealing-to-prohibit-an-acquiring-entity-from-diverting-revenues-to-depress-payouts-under-a-contingent-purchase-price-provisio/

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