Private Equity Buyer Validly Terminates Transaction by Way of “Accurate in all respects” Bring-Down Standard

On May 29, 2023, Chancellor Kathaleen McCormick of the Delaware Chancery Court held in HControl Holdings v. Antin Infrastructure Partners[1] that a private equity sponsor could walk away from its agreement to acquire a company for $250 million because a $215,000 ownership claim by an ex-employee constituted a breach of the sellers’ bring-down condition. This decision underscores the importance of understanding the common variants in M&A bring-down standards and how each variant allocates risk among the parties.

Legal Background

When M&A transactions have an interim period between signing and closing, each party must typically satisfy, among other conditions to closing, a representation and warranty bring-down condition (the “bringing down” of a party’s representations from the date of signing to the date of closing), which sets forth a standard of accuracy for a party’s representations and warranties that must be met as of the closing date to obligate the other parties to consummate the transaction.  

Typically, the bring-down standard for most of the representations relating to the target company is some formulation of “not untrue in such a way that would have a Material Adverse Effect (MAE).” An MAE standard is a very high threshold that provides a certain degree of deal certainty to sellers.[2]

This standard, however, is often not used for the target company’s “fundamental representations,” which are representations that the buyer views as critically important for the transaction, that go to the core of what is being acquired or that are entirely within the sellers’ control. Examples of fundamental representations typically include those relating to the company’s organization and standing, capitalization structure, title to securities, and the seller’s authority and authorization to enter into the contract, among others. Common bring-down standards for fundamental representations are “accurate in all respects”; “accurate in all material respects”; and “accurate in all respects, except for failures, individually and in the aggregate, de minimis in nature.” This variance in bring-down standards for fundamental representations is generally the result of negotiations between the parties.

The Case

On December 3, 2022, Antin Infrastructure Partners S.A.S (“Antin”) signed a merger agreement to acquire a group of privately held Florida-based broadband companies, collectively known as OpticalTel, for a purchase price of $250 million. During the negotiation of the merger agreement, which included seven different drafts before it was finalized, a major point of contention was what bring-down standard should apply to OpticalTel’s capitalization representations. The buyer inserted a “true and correct in all respects” standard, which sellers replaced with a de minimis standard. The final merger agreement required that all of the sellers’ fundamental representations (including with respect to capitalization) be “true and correct in all respects” at the time of closing.

Shortly after signing the merger agreement, a former employee of OpticalTel contacted OpticalTel’s CEO claiming to have an ownership interest in a subsidiary valued at approximately $215,000 based on a 2004 software agreement. Antin was first notified of the issue on January 6, 2023. A representative of Antin testified at trial that they had anticipated the sellers would quickly resolve the issue but following the breakdown of settlement negotiations between the sellers and the ex-employee due to the employee’s purported unreasonable demands, Antin terminated the merger agreement for sellers’ failure to cure the capitalization issue. In connection with Antin’s termination, the sellers filed their complaint in Delaware Chancery Court and asserted, among other claims, that Antin had breached its obligation to use “best efforts” to consummate the merger and, because of the breach, Antin could not validly terminate the contract. The parties moved forward with litigation proceedings expeditiously with a view towards Antin’s debt commitment expiring on June 9, 2023, and conducted a three-day trial in late May.

The court ruled in favor of Antin, holding that Antin had specifically negotiated for the ability to terminate on the basis that the capitalization representations were not accurate in all respects, which they were not, and therefore it was the duty of the court to enforce that right irrespective of the fact that the “capitalization issue” represented approximately 0.86% of the total deal value. Moreover, the court found that Antin had not breached its obligation to use “best efforts” to consummate the merger and thus could validly terminate the merger agreement.

Takeaways

The court made clear that a flat bring-down is just that. As this case illustrates, depending on the bring-down standard, an undisclosed and otherwise insignificant interest in a subsidiary can trigger a right to walk away from a transaction. Unlike more subjective standards of materiality, the court affirmed that even a very small quantum of damages can trip a flat bring-down. Deal teams and their legal counsel must be aware of both (1) the specific language used in the representations and warranties and (2) the bring-down standard that will apply to each representation. If there is any chance a representation may not be entirely accurate, legal counsel needs to ensure that the bring-down standard is sufficiently flexible to allow for an inaccuracy. Indeed, the court highlighted the fact that sellers’ legal counsel had inserted a de minimis carveout into the bring-down provision for the capitalization representation in three separate drafts of the merger agreement before accepting the less flexible standard of “accurate in all respects” (and the risks associated with it). Moreover, this decision begs the question what kind of inaccuracy, if any, would not be considered a breach of a flat bring-down.

What’s more, the court’s decision with respect to sellers’ “best-efforts” claim is also noteworthy because it makes clear that a “best-efforts” provision does not obligate a party to sacrifice a contractual right or work with sellers to find a workable alternative. Indeed, the court found that Antin had satisfied its obligation by simply making reasonable efforts to close the deal such as continuing to work on funds flow issues and voicing its continued commitment to closing the deal while sellers tried to cure the breach of the capitalization representation.  

[1] HControl Holdings LLC v. Antin Infrastructure Partners S.A.S., C.A. No. 2023-0283-KSJM (Del. Ch. May 29, 2023).

[2] Buyers face a “heavy burden” when attempting to use a MAE clause to avoid their obligation to close a transaction. Hexion Specialty Chemicals, Inc. v. Huntsman Corp., 965 A.2d 715, 738 (Del. Ch. 2008). For starters, a MAE must be material when viewed from the long-term perspective of a reasonable buyer; a “short-term hiccup in earnings” is not enough. In re IBP, Inc. S’holders Litig., 789 A.2d 14, 68 (Del. Ch. 2001). The Delaware Court of Chancery has only once allowed a buyer to walk away from a deal because of a MAE. See Akorn, Inc. v. Fresenius Kabi AG, 2018 WL 4719347 (Del. Ch. Oct. 1, 2018). In that case, the Court reaffirmed the rigorous MAE standard from previous Delaware cases, but still released the buyer from its closing obligations because the target’s performance had taken such a dramatic and enduring fall immediately after the merger agreement was signed. Id. at *121–28.