ev3 v. Lesh: Integration Clause that Incorporates Letter of Intent Does Not Make LOI's Non-binding Provisions Binding

Practical Law Legal Update 1-583-2807 (Approx. 6 pages)

ev3 v. Lesh: Integration Clause that Incorporates Letter of Intent Does Not Make LOI's Non-binding Provisions Binding

by Practical Law Corporate & Securities

Background

The case involved the acquisition via merger agreement of Appriva Medical, Inc., a California corporation, by ev3, Inc., a private-equity-owned medical-device maker. Appriva, founded by plaintiffs Dr. Michael Lesh and Erik van der Burg (the shareholder representatives under the merger agreement), was founded to develop "PLAATO," a medical device for the treatment of blood clots.

The Letter of Intent and Merger Agreement

In 2002, ev3 approached Appriva with an unsolicited offer to purchase the equity of Appriva for total consideration of $190 million. Of that purchase price, $115 million would be paid upfront and the remainder would be paid as certain regulatory milestones on the way to PLAATO's approval for sale would be achieved.

During the course of their negotiations, the parties signed an LOI reflecting the preliminary terms for a deal. The LOI was non-binding, with customary exceptions for provisions such as confidentiality and exclusivity that were specifically designated as binding. The LOI specifically called out the non-binding nature of the letter with a provision stating that:

"It is expressly understood that this letter agreement merely sets forth a preliminary statement of intentions with respect to the Contemplated Transaction, . . . [it] does not constitute an obligation binding on ev3. . . . A binding agreement with respect to the Contemplated Transaction will result only from the execution of a definitive agreement with respect thereto and will be entirely subject to the terms and conditions contained therein."

Among the letter's non-binding provisions was a funding provision that would, if included in the definitive agreement, function as an efforts covenant on ev3 to help satisfy the earn-out's regulatory milestones. The provision contemplated that ev3 would commit to funding Appriva, based on projections prepared by management, to ensure that Appriva had sufficient capital to achieve those milestones.

The parties eventually came to an agreement on a definitive merger agreement that diverged from the terms of the LOI in several ways. The final consideration package rose to a total potential amount of $225 million, but with only $50 million being paid upfront. The remaining $175 million would be paid in four possible tranches as certain specified milestones (such as FDA approval and enrollment of patients in a registry) were met. The merger agreement did not, however, include anything like the LOI's funding provision. On the contrary, the agreement provided that ev3 would have the discretion to fund Appriva as it saw fit. Section 9.6 of the agreement stated that:

"Notwithstanding any other provision in the Agreement to the contrary, from and after the closing, [ev3's] obligation to provide funding for the Surviving Corporation, including without limitation funding to pursue achievement of any of the Milestones, shall be at [ev3's] sole discretion, to be exercised in good faith."

The record reflected that Appriva had attempted to include a binding obligation in the merger agreement that would have required ev3 to commit to a pre-determined business plan detailing a specific funding schedule to meet the relevant milestones. The record also reflected that ev3 rejected this proposal and that Appriva did not pursue the matter further.

The merger agreement also contained the following integration clause:

"This Agreement contains the entire understanding among the parties hereto with respect to the transactions contemplated hereby and supersedes and replaces all prior and contemporaneous agreements and understandings, oral or written, with regard to such transactions, other than the Letter of Intent, dated March 15, 2002, as amended. All exhibits and Schedules hereto and any documents and instruments delivered pursuant to any provision hereof are expressly made a part of this Agreement as fully as though completely set forth herein."

By its terms, therefore, the merger agreement superseded all prior agreements and understandings between the parties, except for the terms of the LOI. Nothing in the integration clause or elsewhere in the merger agreement explicitly converted any of the LOI's non-binding provisions into binding obligations. The dispute between ev3 and the plaintiff stockholders was therefore based largely on whether the import of the integration clause, by virtue of its inclusion in a binding merger agreement and its reference to the entire LOI, was that the LOI survived in full, with every term in the LOI made binding. Alternatively, the plaintiffs argued that the integration clause allowed for the funding provision of the LOI to be used to interpret the bounds of ev3's discretion under Section 9.6. By this reading, ev3 would have the discretion to determine how it would fund Appriva's capital, but that it ultimately would have to provide those funds in accordance with management's projections and could not simply opt out of the funding obligation.

The Jury Trial

Soon after the closing of the merger, ev3 concluded that further development of PLAATO would be a sunk cost and halted any further funding. Once the plaintiff stockholders realized that the regulatory milestones for payment of the earn-out were not going to be met, they sued ev3 for breach of contract. The plaintiffs argued that ev3 not only breached the merger agreement by not making its decision to withhold funds in good faith (the standard in Section 9.6 of the agreement), but also breached the funding provision of the LOI. In the plaintiffs' view, the funding provision represented a standalone contractual promise from ev3 that had been made binding by virtue of the merger agreement's integration clause.

The suit proceeded to a jury trial at the Delaware Superior Court. Over ev3's objections, the Superior Court accepted the plaintiffs' argument that the LOI was not inadmissible parol evidence, but a part of the entire agreement between the parties. At the same time, the Superior Court excluded evidence of the negotiating process that demonstrated that the very inclusion of Section 9.6 in the merger agreement was the product of ev3's rejection of Appriva's attempt to turn the non-binding funding provision into an explicit, binding obligation in the merger agreement. In light of these rulings and their effect on the evidence presented to the jury, the jury found that ev3 had breached its contractual promises and awarded the plaintiffs $175 million in damages, the full potential amount of the earn-out.

ev3 filed motions for judgment as a matter of law and a new trial, which were denied by the Superior Court (Lesh v. ev3, Inc., C.A. No. 05C-05-218-CLS, (Del. Super. Aug. 29, 2013)). ev3 appealed to the Supreme Court, requesting a reversal of the Superior Court's order denying ev3's motion for a new trial.

Outcome

The Delaware Supreme Court reversed the Superior Court's order denying the motion for a new trial and remanded the case for new proceedings.

In its decision, the Supreme Court focused on ev3's major argument, that the Superior Court erred by permitting the plaintiffs to argue that the non-binding funding provision in the LOI was in fact binding, either as an independent promise or as a limitation on the sole discretion given to ev3 in Section 9.6 of the merger agreement. The Supreme Court agreed, stating succinctly that "survival is not transformational." As the Court explained, the reference to the LOI in the integration clause did not convert the LOI's non-binding provisions into binding contractual obligations. Rather, the allowance for the LOI to survive meant only that those provisions in the LOI that had been made expressly binding would not be extinguished by the integration clause. As is common practice in M&A deals, buyers and sellers frequently enter into confidentiality agreements that they do not want released just because they have entered into a merger agreement. Saving agreements like those is the purpose of the carve-out to the superseding language in the integration clause, not to convert all preliminary understandings into binding agreements.

In addition, Section 9.6 of the merger agreement in any event began with the phrase "Notwithstanding any other provision in the Agreement to the contrary." Consequently, even if the LOI's funding provision could be considered to have been converted into a binding one and incorporated into the merger agreement, it would still have been made subject to ev3's discretionary authority under Section 9.6. Because the merger agreement was entered into after the LOI, the rules of contract interpretation would require that the earlier, inconsistent funding provision be disregarded.

Having ruled that a new trial must be held on the breach of contract claim, the Supreme Court did not address ev3's additional argument that the Superior Court's jury instructions on the meaning of Section 9.6's good-faith standard were erroneous. The plaintiffs and ev3 had argued over the instructions to be administered to the jury regarding the meaning of contractual good faith. ev3 had argued that to be found to have breached that standard, it should be found to have acted in bad faith (a standard reminiscent of the Supreme Court's definition in Brinckerhoff v. Enbridge Energy Company, Inc., 67 A.3d 369, 373 (Del. 2013)). By contrast, the plaintiffs sought an instruction that defined good faith as "honesty in fact, faithfulness to the purpose of the contract, and behaving in a manner that allows both parties to obtain the benefits for which they contracted." The Superior Court ultimately gave the jury its own instruction based on a variety of definitions drawn from several sources.

Here, the Supreme Court explained that the Superior Court did not at the time have the benefit of the Supreme Court's subsequent decision in DV Realty Advisors LLC v. Policemen's Annuity and Benefit Fund of Chicago, 75 A.3d 101 (Del. 2013). In DV Realty, the Supreme Court (citing to Brinckerhoff) held that when a trial court is addressing an express contractual provision requiring the exercise of good faith, it must focus on whether the breaching party had acted in subjective bad faith based on the circumstances existing at the time of its alleged breach.

Although the Supreme Court here essentially agreed with ev3's understanding of how a contractual good-faith standard should be interpreted, it did not craft its own jury instructions for use by the Superior Court. The Supreme Court reasoned that the Superior Court would be best positioned to craft instructions that would take the facts of the case into account, such as if ev3 had purposely delayed meeting a milestone solely to avoid making the corresponding payment to Appriva. As the Court explained, under DV Realty, it could not constitute bad faith for ev3 to refuse to proceed with funding for PLAATO if doing so, after taking into account the milestones and development costs, was not expected to yield ev3 a commercially reasonable profit. However, it could be bad faith if the expected profits to ev3 were commercially reasonable and ev3 nonetheless acted to delay accomplishment of the milestones so as to shift additional profits its way at the expense of the former Appriva stockholders. The Superior Court would be in a better position to judge whether ev3 had taken that kind of action and thereby craft the appropriate jury instructions.

Practical Implications

The decision in ev3 v. Lesh sheds light on a potential pitfall in many acquisition agreements. Using Standard Clause, Boilerplate Clauses: Section 10 as an example, an acquisition agreement will often state in the integration clause that "this agreement," together with certain named ancillary agreements, constitute the entire agreement of the parties. This sentence does not usually specify any particular provisions of those agreements, but incorporates them wholesale into the overall agreement. ev3 v. Lesh confirms that this language does not convert any non-binding provisions in those ancillary agreements into binding provisions, even though the entire ancillary agreement is incorporated by reference. If a party (for these purposes, usually the seller) wishes to make binding a provision that was initially non-binding, it must include that term explicitly in the definitive agreement.

The drafting of Practical Law's Standard Clause essentially makes this point clear in the second sentence. There it says that in case of any inconsistency between a statement in the body of the definitive agreement and a statement in an ancillary document, the definitive agreement controls. The Supreme Court's opinion implies that the agreement between ev3 and Appriva did not contain this clarification.

ev3 v. Lesh: Integration Clause that Incorporates Letter of Intent Does Not Make LOI's Non-binding Provisions Binding | Practical Law