Earn-out Provision of Merger Agreement Requires Extrinsic Evidence to Aid Interpretation
In Western Standard, LLC, v. SourceHOV Holdings, Inc. and Pangea Acquisitions, Inc., C.A. No. 2018-0280-JRS (Del. Ch. July 24, 2019), the Delaware Court of Chancery (the “Court”) refused to the grant SourceHOV Holdings, Inc. (“SourceHOV”) and Pangea Acquisitions, Inc.’s (“Pangea”) motion to dismiss, holding that more extrinsic evidence was needed for the Court to be able to interpret the terms of the merger agreement (the “Merger Agreement”) among Pangea and BancTec, Inc. (“BancTec”) and decide whether there was a valid breach of a contract claim.
In early 2014, Pangea acquired BancTec through a merger of BancTec and a Pangea subsidiary. The Merger Agreement provided for an earn-out to former BancTec stockholders in the event that Pangea’s controlling stockholder realized certain returns, as outlined in a formula in the Merger Agreement, on its post-merger stock. Unlike a typical earn-out provision that is tied to defined performance milestones, this earn-out is tied to certain shares and certain designated events with respect to those shares.
Following this merger, Pangea underwent two more mergers. First, in September 2014, SourceHOV and Pangea executed a merger agreement whereby SourceHOV created a merger subsidiary that merged into Pangea, with Pangea surviving as a subsidiary of SourceHOV. Second, In July 2017, SourceHOV merged with and survived as a subsidiary of a special purpose acquisition company called Quinpario Acquisition Corp. 2, which then changed its name to Exela.
Plaintiff, Western Standard, LLC, (“Western Standard”) the stockholder representative for BancTec stockholders as designated in the Merger Agreement, alleged the earn-out was triggered by the 2017 stock-for stock merger and requested books and records and the payment of the earn-out consideration. SourceHOV and Pangea disagreed and refused to pay or provide Western Standard with the requested books and records. Hence, the breach of contract claim.
According to SourceHOV and Pangea, the Court did not need to engage in any interpretation of the Merger Agreement because the stock to which the earn-out right attached was extinguished in the 2014 merger between SourceHOV and Pangea and thus was no longer relevant. Alternatively, they argued the unambiguous terms of the Merger Agreement reveal that no earn-out payment is due. They sought dismissal of Western Standard’s breach of contract claim on both grounds under Chancery Rule 12(b)(6).
Western Standard, on the other hand, argued that the controlling stockholder’s Pangea stock remained intact after the 2014 merger, and that SourceHOV and Pangea’s failure to pay the earn-out consideration violated the clear and unambiguous terms of the Merger Agreement. Alternatively, it maintained that the Merger Agreement is ambiguous and, thus, the parties must be afforded an opportunity to present extrinsic evidence in support of their proffered constructions.
The Court found Western Standard’s position to be more persuasive. According to the Court, Pangea emerged from the 2014 merger looking very much as it did before the merger. Its certificate of incorporation and bylaws remained unchanged and it continued to be controlled by the same stockholders. It therefore concluded SourceHOV and Pangea’s argument that the stock to which the earn-out right was attached no longer existed in 2017 could not be supported.
Furthermore, after reading the Merger Agreement more than a dozen times, the Court could not find any way to understand the path by which the parties intended for the earn-out to be triggered and paid, and it did not find the proffered interpretations of any of the parties in any way conclusive or persuasive. According to the Court, the provisions at issue raised more questions than answers and therefore more extrinsic evidence was needed for the Court to be able to make any sense of them whatsoever.
In conclusion, the Court refused to dismiss the action against SourceHOV and Pangea and ordered them to provide Western Standard with the requested books and records, as required under the Merger Agreement. Furthermore, all parties were ordered to provide extrinsic evidence in support of their positions.
This post features contributions from Pouya D. Ahmadi.