(Article from Securities Law Alert, April 2017)
For more information, please visit the Securities Law Alert Resource Center
On March 23, 2017, the Delaware Supreme Court affirmed a June 2016 Chancery Court decision holding that a buyer had not breached its requirement to use “commercially reasonable efforts” to obtain a tax opinion required as a condition precedent to a merger agreement. The Williams Cos. v. Energy Transfer Equity, 2017 WL 1090912 (Del. 2017) (Vaughn, J.) (Williams II). However, the court found that the Chancery Court had “erred . . . by focusing on the absence of any evidence to show that [the buyer] caused [the law firm] to withhhold the [tax] opinion.” The Delaware Supreme Court held that the “commercially reasonable efforts” clause “placed an affirmative obligation on the parties to take all reasonable steps to obtain the [tax] opinion.”
The court further ruled that “once a breach of a covenant is established, the burden is on the breaching party to show that the breach did not materially contribute to the failure of the transaction.”
Chancery Court Took an “Unduly Narrow” View of Hexion in Interpreting the “Commercially Reasonable Efforts” Clause
In considering whether the buyer had breached the “commercially reasonable efforts” clause, the Chancery Court found dispositive the absence of any evidence either that the buyer had “obstruct[ed] [the law firm’s] issuance of the condition-precedent [tax] [o]pinion” or that the buyer’s actions “had a material effect on [the law firm’s] decision” not to issue the tax opinion. The Williams Cos. v. Energy Transfer Equity, 2016 WL 3576682 (Del. Ch. June 24, 2016) (Glasscock, V.C.) (Williams I).[1]
The Williams I court distinguished the Chancery Court’s earlier decision in Hexion Specialty Chemicals v. Huntsman Corp., 965 A.2d 715 (Del. Ch. 2008). There, the court held a buyer in breach of a contractual obligation to use “reasonable best efforts” to obtain financing for a merger transaction. The Williams I court found that “in Hexion, the buyer [had] actively and affirmatively torpedoed its ability to finance” the merger by “knowingly” providing its financial advisor with misleading information concerning the transaction. The Williams I court reasoned that “[i]f the record here reflected affirmative acts by [the buyer] to coerce or mislead [the law firm], by which actions it prevented the issuance of the [tax opinion], the facts here would more resemble Hexion and the outcome here would likely be different.”
On appeal, the Delaware Supreme Court found the Williams I court had taken “an unduly narrow view of Hexion.” Williams II, 2017 WL 1090912. The Delaware Supreme Court explained that in Hexion, the court stated that “to the extent that an act was both commercially reasonable and advisable to enhance the likelihood of consummation of the financing, the onus was on [the buyer] to take that act.” Id. (quoting Hexion, 965 A.2d 715) (emphasis added by the Williams II court). The Delaware Supreme Court determined that “Hexion . . . recognized that covenants like the ones involved here impose obligations to take all reasonable steps to solve problems and consummate the transaction.”[2] The Delaware Supreme Court agreed with the seller that the Williams I court had erroneously interpreted the “commercially reasonable efforts” clause “as imposing only a negative duty not to thwart or obstruct performance . . . rather than an affirmative duty to help ensure performance.”
Even If the Buyer Breached the “Commercially Reasonable Efforts” Clause, the Breach Did Not Materially Contribute to the Failure of the Tax Opinion Condition
The Delaware Supreme Court found that “once a breach of a covenant is established, the burden is on the breaching party to show that the breach did not materially contribute to the failure of the transaction.” The court made it clear that “[t]he plaintiff has no obligation to show what steps the breaching party could have taken to consummate the transaction.”
The Delaware Supreme Court explained that here, the Chancery Court “did not separately analyze in the text of its opinion whether a breach of the covenant materially contributed to the failure of the transaction” because the court found no predicate breach by the buyer. However, the Chancery Court did observe in a footnote that the result would have been the same regardless of how it allocated the burden of proof because there was no evidence in the record that “the action or inaction of the [buyer] . . . contributed materially to [the law firm’s] inability to issue the [tax] [o]pinion.” Id. (quoting Williams I, 2016 WL 3576682). The Chancery Court determined that this would have been “true regardless of whether [the buyer’s] actions were commercially reasonable.” Id. (quoting Williams I, 2016 WL 3576682).
The Delaware Supreme Court found the Chancery Court’s analysis was “based on findings of fact which [were] not clearly erroneous,” and affirmed the Chancery Court’s decision.
Chief Justice Strine, Dissenting, States the Buyer Should Have Been Required to Prove That Its Conduct Did Not Materially Contribute to the Failure of the Tax Opinion Condition
In a lengthy dissent, Chief Justice Strine expressed his view that the Chancery Court “did not view the case through the appropriate lens” and applied an incorrect standard in evaluating the buyer’s actions. He stated that because the “commercially reasonable efforts” clause “obligated [the buyer] to take affirmative steps to make sure the [tax] opinion condition was satisfied and, instead, [the buyer] did not,” the buyer was required to “prove that the [tax] opinion condition would not have been satisfied had it acted appropriately.”
Chief Justice Strine explained that he would have “remand[ed] and require[d] a new trial at which [the buyer] would [have been] required to prove that its breach did not materially contribute to the failure of the [law firm] to deliver the [tax] opinion.”
[1] Please click here to read our prior discussion of the Chancery Court’s decision in Williams I.
[2] The merger agreement at issue in Williams I and II not only “required the parties to use ‘commercially reasonable efforts’ to obtain the [tax] opinion” but also obligated the parties “to use ‘reasonable best efforts’ to consummate the transaction.” Williams II, 2017 WL 1090912.