Shareholder Releases and Letters of Transmittal

Any time a board or majority shareholders approve the sale of a company, they run some risk that an objecting shareholder may sue them for an alleged breach of duties in taking that action. While a number of steps can be taken to reduce this risk, it typically cannot be eliminated entirely. Even with good exits, a shareholder can always try to argue that the company could have done better. Recent cases, such as In re Trados Inc. Shareholder Litigation,¹ are concrete examples of the litigation risks inherent in approving mergers.

To address these risks, some practitioners put release language in the letters of transmittal and state that shareholders must execute them in order to receive their merger consideration. Proposed language would say generally that the signing shareholder releases the board, the other shareholders, the selling company, the buyer, and everyone else related to the deal, from any and all claims related to the merger, and waives any right to bring a suit related to the transaction.

While that language has obvious appeal for the parties tasked with considering whether to approve the transaction, there are some potential challenges. First, it works only if a shareholder sends in his or her letter of transmittal. If a shareholder is not getting consideration in the transaction, or feels that the consideration is insufficient, he or she likely will not agree to a release. Second, it is unlikely a company can withhold merger consideration that a shareholder is entitled to receive if that shareholder does not agree to sign a release when there is arguably no obligation to sign. This will put the parties in a difficult spot if the shareholder demands the money but will not agree to any release of claims. In Cigna Health and Life Insurance Co. v. Audax Health Solutions, Inc., the Court of Chancery of Delaware held that the buyer could not withhold merger consideration for a shareholder’s refusal to sign a letter of transmittal when there was no clear consideration in exchange.² The Court noted that the merger agreement did not indicate that shareholders had to agree to a release to receive their merger consideration, and the letter of transmittal was therefore a new obligation placed upon the shareholders not contemplated in the merger agreement itself.

The third challenge is related to the second. If a shareholder is entitled to receive merger consideration regardless of whether it signs a release, the shareholder could argue that the release is not enforceable even if signed, because of lack of consideration. In other words, it can be argued that the shareholder agreed to the burdens of a release but got nothing in return that he or she was not already entitled to receive. One possible fix to provide greater comfort on these issues would be to specifically state in the merger agreement that a portion of the merger consideration is being paid in exchange for the acquired shares, and a portion is being paid in exchange for the release of all parties as sought by the buyer. This is similar to transaction structures in which the buyer requires a portion of the purchase price to be considered as payment in exchange for noncompetition agreements from the shareholders to ensure their enforceability. This, however, leaves the possibility that a shareholder could simply decline to accept the portion being paid for the release and be free of such obligations. Also, such a structure likely creates adverse tax consequences.

Finally, attorneys must consider whether they can make a statement that receipt of the merger consideration is subject to the execution of a letter of transmittal containing a release if that is not legally correct. When considering adding a release to a letter of transmittal, the implications should be reviewed by tax and corporate counsel.

¹ 73 A.3d 17 (Del. Ch. 2013).

² 107 A.3d 1082, 1091 (Del. Ch. 2014).