Impact of the Cigna Health Decision on the Use of the Merger Structure in Private Acquisitions

When buying a private company controlled by a private equity sponsor but with a substantial number of other shareholders, a common technique to avoid the need to obtain signatures from all the shareholders to a stock purchase agreement is to effect the transaction by way of a merger, that once approved by the requisite shareholders, binds all shareholders to the transaction. The recent Delaware court decision in Cigna Health raises some challenges that practitioners will need to manage when using the merger structure. Since all shareholders would not be signing the merger agreement, it was also common to require a shareholder to submit a signed letter of transmittal as a condition to receiving its merger consideration, and to include in the letter of transmittal not only a representation regarding ownership of the stock being tendered, but also an agreement to be bound by various post-closing obligations, such as indemnity obligations, appointment of a shareholder representative to settle indemnity claims or post-closing purchase price adjustments, and a release of all claims against the transaction participants other than for the merger consideration. In some instances, we have even seen efforts to include non-compete and non-solicitation covenants in letters of transmittals.

The recent decision of the Delaware Court of Chancery, Cigna Health and Life Ins. Co. v. Audax Health Solutions, Inc.,¹ has called into question the continued viability of this technique by holding that certain post-closing indemnity obligations and shareholder release provisions in the letter of transmittal were unenforceable against Cigna. However, the Court’s holding was narrowly tailored to the facts of the case, and while Cigna may have created more questions than it answers, through practical techniques and diligent planning, buyers can mitigate the effects of this decision.

In Cigna, the Court held two provisions of the intended merger structure unenforceable against a non-signatory shareholder of the acquired company; (a) a post-closing indemnity obligation to the extent that it put 100% of the merger consideration at risk of repayment to the acquiror for an indefinite period of time and (b) a broadly-worded shareholder release in a letter of transmittal that was sent to shareholders after the merger was consummated. Regarding the shareholder release, the Court determined that the shareholder is entitled by law to the merger consideration as a...