Corporate > AG Deal Diary > Delaware Supreme Court applies ‘reasonable conceivability’ standard and addresses earn-out and indemnification provisions
12 Nov '13

Last month, in Winshall v. Viacom International, the Delaware Supreme Court applied the “reasonable conceivability” standard to a motion to dismiss and addressed the earn-out and indemnification provisions in a merger agreement.

The opinion highlights the importance of using clear and specific language to clarify the intent of the parties. 

The case was brought by selling stockholders based on the earn-out provisions in the 2006 merger agreement entered into between Viacom International and Harmonix Music Systems, in which Viacom acquired Harmonix. In addition to a $175 million cash payment at closing, the merger agreement provided a contingent right to the selling stockholders to receive certain earn-out payments during 2007 and 2008 based on financial performance, but it did not explicitly require Harmonix to conduct its business so as to maximize the earn-out payments. The merger agreement also contained an indemnification provision requiring the selling stockholders to indemnify and hold harmless Viacom and Harmonix and their affiliates from and against any losses arising out of or by reason of the breach of any representation or warranty of the company in the merger agreement.

In its review of the defendant’s motion to dismiss, the Supreme Court confirmed the use of the “reasonable conceivability” standard, as it did in Central Mortgage v. Morgan Stanley Mortgage Capital Holdings (2011). This standard asks whether, “with all reasonable inferences drawn in favor of the plaintiff, the amended complaint alleges a reasonably conceivable set of facts under which the plaintiff would be entitled to relief.” It is less rigorous than the federal pleading standard in Bell Atlantic v. Twombly (2007) and Ashcroft v. Iqbal (2009), which requires that a complaint must “state a claim to relief that is plausible on its face.”

With respect to the earn-out provisions, plaintiffs claimed that Harmonix had an implied obligation under the merger agreement to take advantage of an opportunity to increase the amount of the 2008 earn-out payment by renegotiating the distribution fees of a new video game (Rock Band). The Supreme Court, however, agreed with the Court of Chancery’s decision that such obligation could not be implied and that the implied covenant of good faith and fair dealing cannot be applied to give plaintiffs contractual provisions they failed to negotiate themselves.

Regarding the indemnification provisions, Viacom’s cross-appeal claimed it was entitled to indemnification for breaches of representations and warranties by the selling stockholders relating to subsequent third party intellectual property claims, and that even absent a breach, the selling stockholders should pay Viacom’s defense costs in such claims. The Supreme Court also agreed with the Chancery Court that there was no such breach of the representation and warranties, and that without a breach, the selling stockholders did not have an independent contractual duty to pay Viacom’s defense costs. The indemnification provision only provided for a duty to “indemnify . . . and hold them harmless,” and did not create separate duties to indemnify and defend, which would require language such as “indemnify and defend against claims.” In addition, the Supreme Court found that the indemnification obligation did not include a right to the legally distinct concept of advancement (or the right to payment of defense costs as they are incurred, whether or not the party is ultimately entitled to indemnification).