DE Court Adheres to Plain Meaning of Acquisition Agreement Terms

Harmonix was “a developer of music-based video games,” including a popular product known as “Rock Band.” In October 2006, Viacom closed its purchase of Harmonix pursuant to a merger agreement that paid Harmonix stockholders $175 million in cash plus an earn-out tied to 2007 and 2008 performance. Twelve million dollars of the purchase price was placed in escrow to secure the former stockholders' indemnification obligations to Viacom for breaches of representations and warranties made in the merger agreement. The escrow by its terms was to be released 18 months following closing, to the extent not theretofore tapped for indemnity payments. Walter Winshall was appointed as the representative of the former Harmonix stockholders to, among other things, negotiate indemnity claims asserted by Viacom post-closing.

At the time of the closing, Harmonix was in the midst of developing Rock Band, but the product was not released commercially by Viacom until November 2007, over a year after its acquisition of Harmonix. In April 2008, just a few days before the scheduled expiration of the escrow, Viacom made several indemnification claims, each relating to alleged breaches of merger agreement representations concerning the intellectual property underlying the Rock Band software. Viacom's claims were prompted by three separate lawsuits filed by third parties claiming rights in the software and infringements thereof by Viacom. Viacom's indemnity claim also prophetically stated that “it 'hereby reserve[d] the right to seek indemnification for any other claims or matters by the parties named above or other third parties that may result due to the [Harmonix's] breach of its representations and warranties under the [Merger] Agreement.'” Then, almost three months after expiration of the escrow, a fourth infringement claim was brought against Viacom, and Viacom in turn notified Winshall that it was seeking indemnification in respect of this claim as well.

Viacom was relatively successful in these actions, settling one and seeing the other three dismissed with prejudice. Viacom asserted that its costs of defending these actions exceeded $28 million, and sought reimbursement from the escrow of this amount as well as its settlement payment. Winshall rejected these claims and demanded release of the escrow in full. When Viacom refused, Winshall filed a complaint with the Court of Chancery seeking release of the escrow and moved for summary judgment.

The Parties' Contentions

The merger agreement contained fairly traditional language concerning Viacom's right to seek indemnification for breaches of Harmonix representations and warranties. The selling stockholders agreed to “indemnify Viacom 'against any and all Losses' arising out of 'the breach of any representation or warranty of [Harmonix] contained in this Agreement.'” Any indemnification claim relating to any non-fraudulent breach of a representation or warranty relating to intellectual property matters was required to be made within 18 months following closing. The intellectual property representations that Viacom claimed had been breached referred to ” ' 'the current use' of software” developed by Harmonix and ” ' the operation of the Business ' [and] any activity of the Company ' .” Winshall asserted that Harmonix's representations and warranties spoke as of the date of the merger agreement while the infringement actions brought against Viacom arose from a product developed and released following closing.

With respect to any claim brought by Viacom, the merger agreement provided that the former stockholders also were “liable for the costs of Viacom's defense of these claims.” Further, the merger agreement gave Viacom “the right to conduct the defense of any claim 'at the expense of the applicable indemnifying parties.'” Similarly, “if Viacom chooses not to permit Winshall to assume the defense ' , Winshall shall pay 'the reasonable fees and expenses of counsel retained by [Viacom].” Viacom argued that “the Sellers are responsible for paying its defense costs 'if the allegations of the claim at issue fall within the scope of the representation or warranty,'” “even if there was no breach of the representations and warranties.”

The Court of Chancery's Analysis

The court rejected Viacom's claims, and granted Winshall summary judgment in his attempt to recoup the escrow, on several grounds. It should also be noted that the court also held in Winshall's favor in respect of Viacom claims that representations and warranties made “to the knowledge of the Harmonix officer” were breached, explaining that Viacom failed to produce any evidence that the officers had any knowledge of the claimed misrepresentations.

Expense Reimbursement

The court viewed Viacom's assertion that it was entitled to expense reimbursement for its defense costs ' “even if there was no breach of the representations and warranties” ' as taking the express words of the merger agreement “out of their contractual and logical context.” Based on Viacom's argument, the court reasoned, “[t]he Sellers could thus be on the hook for defending against frivolous claims that had nothing at all to do with the state of Harmonix when they sold it to Harmonix.” The court found that this “interpretation of the Merger Agreement contradicts its plain text and evident logic ' .”

Rather, to collect reimbursement of its expenses, “Viacom must show that there has been ' a breach.” The court premised this finding on, among other things, the language of the merger agreement providing that “defense fees will only be paid by the 'indemnifying parties.' This makes clear that, for the Sellers to cover Viacom's costs, Viacom's right to indemnification must have been triggered.”

Pre-Escrow Termination Claims

With respect to the first three infringement claims brought against Viacom, the court found that the relevant representations and warranties in the merger agreement “refer to the use of the intellectual property in October 2006, when Viacom purchased Harmonix.” In reaching this conclusion, the court focused on the use of the terms “current use” with reference to Harmonix's intellectual property and “as currently conducted” with reference to Harmonix's business. This language led the court to conclude, “it is clear that the representation only covers the present time, not the future.”

By contrast, the subject matter of the infringement claims “all relate to final Rock Band video game that was produced in November 2007,” many months after the closing of Viacom's purchase of Harmonix. In the court's view, “there is no reason why the Sellers might have indemnified Viacom against losses arising out of infringements of intellectual property rights that took place at the time of Rock Band's publication in 2007, when the Sellers no longer controlled Harmonix.” In fact, the court thought it would be “strange” indeed if the former Harmonix stockholders' indemnification obligations extended to these claims.

Post-Escrow Termination Claim

The court had even less sympathy for Viacom's escrow claim relating to the infringement action brought after the scheduled expiration of the escrow. Viacom argued that its initial indemnity claim contained a “placeholder” that allowed it so seek indemnity for third-party infringement claims brought more than 18 months following closing. Such a reading would, in the court's view, “constitute a unilateral rewriting of the contract and is impermissible.” Thus, the court found this aspect of Viacom's claim to be “time-barred.”

Conclusion

The decision of the Court of Chancery in Winshall v. Viacom International Inc. may not be surprising, but it certainly is of comfort to dealmakers and practitioners who are responsible for negotiating and documenting M&A transactions. The decision highlights the importance of careful and considered drafting. The Delaware courts will hold contracting parties to the language used in their acquisition agreements.

Robert S. Reder has been serving as a consulting attorney at Milbank, Tweed, Hadley & McCloy LLP since his retirement as a partner in April 2011. A member of this newsletter's Board of Editors, Mr. Reder also is serving as an Adjunct Professor at Vanderbilt Law School and at Fordham Law School.

Consistency in the interpretation and application of frequently used language and constructs in acquisition agreements is certainly a key element in giving corporate dealmakers the confidence to pursue M&A transactions. Accordingly, it is comforting when a dispute over the meaning of familiar M&A agreement provisions is resolved by a court in a manner consistent with the common understanding of how these provisions should work.

Such was the case in a recent decision of the Delaware Court of Chancery in Winshall v. Viacom International Inc., Civil Action No. 6074-CS (Del. Ch. Dec. 12, 2012). By granting summary judgment to selling stockholders in a dispute with media giant Viacom International over its 2006 purchase of Harmonix Music Systems, the court refused to allow Viacom to proceed with claims that the language of its acquisition agreement did not support.

Factual Background

Harmonix was “a developer of music-based video games,” including a popular product known as “Rock Band.” In October 2006, Viacom closed its purchase of Harmonix pursuant to a merger agreement that paid Harmonix stockholders $175 million in cash plus an earn-out tied to 2007 and 2008 performance. Twelve million dollars of the purchase price was placed in escrow to secure the former stockholders' indemnification obligations to Viacom for breaches of representations and warranties made in the merger agreement. The escrow by its terms was to be released 18 months following closing, to the extent not theretofore tapped for indemnity payments. Walter Winshall was appointed as the representative of the former Harmonix stockholders to, among other things, negotiate indemnity claims asserted by Viacom post-closing.

At the time of the closing, Harmonix was in the midst of developing Rock Band, but the product was not released commercially by Viacom until November 2007, over a year after its acquisition of Harmonix. In April 2008, just a few days before the scheduled expiration of the escrow, Viacom made several indemnification claims, each relating to alleged breaches of merger agreement representations concerning the intellectual property underlying the Rock Band software. Viacom's claims were prompted by three separate lawsuits filed by third parties claiming rights in the software and infringements thereof by Viacom. Viacom's indemnity claim also prophetically stated that “it 'hereby reserve[d] the right to seek indemnification for any other claims or matters by the parties named above or other third parties that may result due to the [Harmonix's] breach of its representations and warranties under the [Merger] Agreement.'” Then, almost three months after expiration of the escrow, a fourth infringement claim was brought against Viacom, and Viacom in turn notified Winshall that it was seeking indemnification in respect of this claim as well.

Viacom was relatively successful in these actions, settling one and seeing the other three dismissed with prejudice. Viacom asserted that its costs of defending these actions exceeded $28 million, and sought reimbursement from the escrow of this amount as well as its settlement payment. Winshall rejected these claims and demanded release of the escrow in full. When Viacom refused, Winshall filed a complaint with the Court of Chancery seeking release of the escrow and moved for summary judgment.

The Parties' Contentions

The merger agreement contained fairly traditional language concerning Viacom's right to seek indemnification for breaches of Harmonix representations and warranties. The selling stockholders agreed to “indemnify Viacom 'against any and all Losses' arising out of 'the breach of any representation or warranty of [Harmonix] contained in this Agreement.'” Any indemnification claim relating to any non-fraudulent breach of a representation or warranty relating to intellectual property matters was required to be made within 18 months following closing. The intellectual property representations that Viacom claimed had been breached referred to ” ' 'the current use' of software” developed by Harmonix and ” ' the operation of the Business ' [and] any activity of the Company ' .” Winshall asserted that Harmonix's representations and warranties spoke as of the date of the merger agreement while the infringement actions brought against Viacom arose from a product developed and released following closing.

With respect to any claim brought by Viacom, the merger agreement provided that the former stockholders also were “liable for the costs of Viacom's defense of these claims.” Further, the merger agreement gave Viacom “the right to conduct the defense of any claim 'at the expense of the applicable indemnifying parties.'” Similarly, “if Viacom chooses not to permit Winshall to assume the defense ' , Winshall shall pay 'the reasonable fees and expenses of counsel retained by [Viacom].” Viacom argued that “the Sellers are responsible for paying its defense costs 'if the allegations of the claim at issue fall within the scope of the representation or warranty,'” “even if there was no breach of the representations and warranties.”

The Court of Chancery's Analysis

The court rejected Viacom's claims, and granted Winshall summary judgment in his attempt to recoup the escrow, on several grounds. It should also be noted that the court also held in Winshall's favor in respect of Viacom claims that representations and warranties made “to the knowledge of the Harmonix officer” were breached, explaining that Viacom failed to produce any evidence that the officers had any knowledge of the claimed misrepresentations.

Expense Reimbursement

The court viewed Viacom's assertion that it was entitled to expense reimbursement for its defense costs ' “even if there was no breach of the representations and warranties” ' as taking the express words of the merger agreement “out of their contractual and logical context.” Based on Viacom's argument, the court reasoned, “[t]he Sellers could thus be on the hook for defending against frivolous claims that had nothing at all to do with the state of Harmonix when they sold it to Harmonix.” The court found that this “interpretation of the Merger Agreement contradicts its plain text and evident logic ' .”

Rather, to collect reimbursement of its expenses, “Viacom must show that there has been ' a breach.” The court premised this finding on, among other things, the language of the merger agreement providing that “defense fees will only be paid by the 'indemnifying parties.' This makes clear that, for the Sellers to cover Viacom's costs, Viacom's right to indemnification must have been triggered.”

Pre-Escrow Termination Claims

With respect to the first three infringement claims brought against Viacom, the court found that the relevant representations and warranties in the merger agreement “refer to the use of the intellectual property in October 2006, when Viacom purchased Harmonix.” In reaching this conclusion, the court focused on the use of the terms “current use” with reference to Harmonix's intellectual property and “as currently conducted” with reference to Harmonix's business. This language led the court to conclude, “it is clear that the representation only covers the present time, not the future.”

By contrast, the subject matter of the infringement claims “all relate to final Rock Band video game that was produced in November 2007,” many months after the closing of Viacom's purchase of Harmonix. In the court's view, “there is no reason why the Sellers might have indemnified Viacom against losses arising out of infringements of intellectual property rights that took place at the time of Rock Band's publication in 2007, when the Sellers no longer controlled Harmonix.” In fact, the court thought it would be “strange” indeed if the former Harmonix stockholders' indemnification obligations extended to these claims.

Post-Escrow Termination Claim

The court had even less sympathy for Viacom's escrow claim relating to the infringement action brought after the scheduled expiration of the escrow. Viacom argued that its initial indemnity claim contained a “placeholder” that allowed it so seek indemnity for third-party infringement claims brought more than 18 months following closing. Such a reading would, in the court's view, “constitute a unilateral rewriting of the contract and is impermissible.” Thus, the court found this aspect of Viacom's claim to be “time-barred.”

Conclusion

The decision of the Court of Chancery in Winshall v. Viacom International Inc . may not be surprising, but it certainly is of comfort to dealmakers and practitioners who are responsible for negotiating and documenting M&A transactions. The decision highlights the importance of careful and considered drafting. The Delaware courts will hold contracting parties to the language used in their acquisition agreements.

Robert S. Reder has been serving as a consulting attorney at Milbank, Tweed, Hadley & McCloy LLP since his retirement as a partner in April 2011. A member of this newsletter's Board of Editors, Mr. Reder also is serving as an Adjunct Professor at Vanderbilt Law School and at Fordham Law School.