Effective as of January 1, 2024, the Corporate Transparency Act, commonly known as the “Rule,” dictates that entities established through state filing procedures, including limited liability companies, corporations, statutory trusts, and similar entities collectively referred to as “Reporting Companies,” must directly submit beneficial ownership information to the Financial Crimes Enforcement Network (“FinCEN”) of the Department of the Treasury. Failure to adhere to the Rule’s reporting requirements could result in civil and criminal penalties.

On November 30, 2023, FinCEN adjusted the Rule’s filing deadline for Reporting Companies created or registered between January 1, 2024, and January 1, 2025, extending the timeframe from 30 to 90 calendar days.

Reporting Companies in existence before January 1, 2024, have until January 1, 2025, to fulfill the reporting obligations, while those established on or after January 1, 2025, must file within 30 days of their formation.

Reports submitted to FinCEN – Beneficial Ownership Information Reports “BOI Reports” -  must identify the Reporting Company and disclose specific personal information about the Beneficial Owners and Applicants.

Two categories of Beneficial Owners are distinguished: those owning or controlling at least 25 percent of ownership interests and those exercising “substantial control” over the Reporting Company. Notably, applicants encompass the individual filing the formation document and the individual primarily responsible for directing or controlling such filing.

The Rule does provide a large number exemptions to the Reporting Company definition. However, these exemptions do not apply to most types of businesses – in general, they are limited to financial institutions, broker dealers and large public companies.  They are generally exempted because these types of businesses are already subject to extensive regulations and requirements with respect to filing of similar types of information.

Entities falling within an exempted category are exempt from filing a BOI Report with FinCEN. Furthermore, the Rule introduces the concept of “FinCEN Identifiers.” Individuals frequently appearing in BOI Reports can request a unique number from FinCEN, providing an alternative to repeatedly transmitting personal information with each BOI Report filing. Entities also have the option to obtain FinCEN Identifiers.

Tags: BOI Report, Corporate Transparency Act, FinCEN, Reporting Company

In the case of Cummings Properties, LLC vs. Darryl C. Hines, the Massachusetts Supreme Judicial Court considered the enforceability of a liquidated damages clause in a commercial lease agreement. The court upheld the clause and ruled in favor of Cummings Properties, LLC.  https://www.mass.gov/files/documents/2023/09/25/p13406.pdf

Here are the key points from the summary:

1. Background: The case involved a commercial lease between Cummings Properties and Massachusetts Constable’s Office, Inc. (MCO), with Darryl C. Hines as the personal guarantor. The lease had a provision for liquidated damages in case of rent default.
2. Liquidated Damages Clause: The liquidated damages clause allowed Cummings Properties to terminate the lease and collect the entire balance of rent due as liquidated damages if MCO failed to pay rent after a ten-day grace period.
3. Default and Lawsuit: MCO failed to pay rent shortly after the lease took effect, leading Cummings Properties to initiate legal action. MCO vacated the premises, and Cummings Properties subsequently leased the space to a new tenant.
4. Enforceability of Liquidated Damages Clause: The central issue was whether the liquidated damages clause was enforceable. The court applied the “single look” approach, which focuses on the circumstances at the time of contract formation.
5. Two-Prong Test: To enforce a liquidated damages clause, two conditions had to be met: (a) actual damages at the time of contract formation were difficult to ascertain, and (b) the sum agreed upon as liquidated damages represented a reasonable forecast of damages in case of a breach.
6. Burden of Proof: Hines, as the party seeking to invalidate the clause, had the burden of proving that either actual damages were easily ascertainable at the time of contract formation or that the damages specified in the clause were disproportionate.
7. Court’s Findings: The court found that Hines failed to provide evidence to support his claims that actual damages were easily ascertainable or that the damages specified in the clause were disproportionate.
8. Mitigation Not Required: The court emphasized that under the single look approach, mitigation of damages, such as rent collected from a new tenant, was not a consideration in determining the enforceability of the liquidated damages clause.
9. Sophistication: Hines argued that he was not a sophisticated party and should not be bound by the clause. The court found that Hines demonstrated some business acumen and sophistication, making him accountable for the contract terms.
10. Judgment: The court affirmed the judgment of the Superior Court, upholding the enforceability of the liquidated damages clause and ruling in favor of Cummings Properties.

In summary, the court upheld the liquidated damages clause in the commercial lease, emphasizing that it was enforceable because it represented a reasonable forecast of damages at the time of contract formation. The court also considered Hines to be sufficiently sophisticated to be held accountable for the contract terms.

Tags: liquidated damages

By: Richard Gauthier

In a recent consumer class action case brought against Uber Technologies, the Massachusetts U.S. District Court held that the binding arbitration clause in Uber’s Terms and Conditions (“Terms”) was enforceable and prevented the consumers from seeking a class action in a court of law.  This decision is noteworthy because along with the ruling on arbitration clauses, it provides a thorough summary of the Massachusetts case law on the enforceability of online agreements.  It also highlights that Massachusetts law is favorable for the enforcement of such online agreements, perhaps more so than New York.

The plaintiffs in this case alleged that Uber overcharged them by imposing fictitious fees hidden in charges for legitimate local tolls. They sought class action relief for unfair and deceptive practices pursuant to Chapter 93A and common law claims for unjust enrichment. Uber moved to enforce the arbitration clause in the Terms pursuant to the FAA, and the Court agreed.

The Terms contained the following provision related to arbitration:

“[You] agree that any dispute, claim or controversy arising out of or relating to this Agreement or the breach, termination, enforcement, interpretation or validity thereof or the use of the Service or Application (collectively, “Disputes”) will be settled by binding arbitration, except that each party retains the right to bring an individual action in small claims court. . . . You acknowledge and agree that you and Company are each waiving the right to a trial by jury or to participate as a plaintiff or class User in any purported class action or representative proceeding. Further, unless both you and Company otherwise agree in writing, the arbitrator may not consolidate more than one person’s claims, and may not otherwise preside over any form of any class or representative proceeding.”

The Court began by analyzing whether the Terms were valid under general Massachusetts contract law principles.  A significant portion of this discussion relies on Ajemian v. Yahoo!, Inc.,  a 2013 Massachusetts court decision that we previously discussed here.  In this analysis, the Court provided a very helpful summary of Massachusetts law on the various types of online agreements:

• Adhesion Contracts:  Massachusetts law applies the same general analysis as other jurisdictions with respect to the enforceability of online adhesion contracts.  Such agreements will be enforced provided they have been “reasonably communicated and accepted” and “it is reasonable to enforce the provision at issue.”

The Court then compared the different types of online agreements, which evolved from shrinkwrap software licenses that have come into use since the computer era:

• A “Browsewrap” agreement is where the user “does not see the contract at all but in which the license terms provide that using a Web site constitutes agreement to a contract whether the user knows it or not”, or “[w]here the link to a website’s terms of use is buried at the bottom of the page or tucked away in obscure corners of the website where users are unlikely to see it.”
• A “Clickwrap” agreement is an online contract “in which website users are required to click on an “I agree” box after being presented with a list of terms and conditions of use.
  • The Court commented that Clickwraps are more enforceable than Browsewraps because they “permit courts to infer that the user was at least on inquiry notice of the terms of the agreement, and has outwardly manifested consent by clicking a box.”
• A “Sign-In-Wrap” Agreement (a term coined in a 2015 decision by Judge Weinstein of the EDNY) is somewhat of a hybrid between the Browsewrap and Clickwrap.  A “Sign-In-Wrap” Agreement does not have an “I accept” button and the user is not required to view the terms and conditions to use the related web service.  These agreements typically make terms and conditions available by link and provide that by registering for an account, or signing into an account, the user agrees to those terms and conditions.

In this case, the Court adopted the “Sign-In-Wrap” terminology and held that such agreements may be enforceable under Massachusetts law.  Here, the Court found that Uber’s Terms were a Sign-In-Wrap agreement.  The Court then summarized Massachusetts law on the enforceability of online agreements in general, as follows:

• Online consumer agreements “will be enforced provided they have been reasonably communicated and accepted and if, considering all the circumstances, it is reasonable to enforce the provision at issue.”
• The party seeking to enforce the contract has “the burden of establishing, on undisputed facts, that the provisions of the online agreement were reasonably communicated and accepted, which requires “[r]easonably conspicuous notice of the existence of contract terms and unambiguous manifestation of assent to those terms by consumers.” 

Reasonably Conspicuous Notice

• The Court held that Massachusetts law does not require proof of actual notice of the terms of the Agreement.  All that is required is that the users have reasonable notice.  Uber’s language on the final screen of the account registration process (“By creating an Uber account, you agree to the Terms of Service & Privacy Policy”) was found sufficient. 
• While the dispute resolution/arbitration clause did not appear until the user scrolled down to the 8th/9th page, the Court was satisfied that the user had reasonable notice because the heading for the clause was in bold and much larger than other non-heading text.
• Notably, the Court refused to adopt the four-step process used by the EDNY Court that first coined the Sign-In-Wrap phrase, which would have required a factual analysis of the actual notice to the user.  The Court held that such an analysis would be impractical and make online agreements much more difficult to enforce, which this Court was unwilling to do.

Manifestation of Assent

• The Court adopted a similar reasonable test for determining whether the user’s assent can be found.  Specifically, the Court held that the “Done” button on Uber’s website (as opposed to “I accept” or other similar buttons) was sufficient for finding that the user understood that by clicking this button it has consummated account registration and was bound by the Terms.

Having found that the Terms were enforceable, the Court quickly made its way to conclude that the binding arbitration clause and the waiver of class action remedies too were enforceable.  The Court noted that this standard favors arbitration and that the only exception would be where the arbitration itself would be an “illusory remedy.” Here, as Uber offered to pick up the arbitration costs for any claims up to $75,000, arbitration would not be illusory and that the clause should be binding.

Tags: 93A, Actual Notice, Adhesion Contract, arbitration, Browsewrap, Class Action, Class Action Waiver, Clickwrap, EULA, Reasonable Notice, Sign-In-Wrap, terms and conditions, Ts&Cs, Uber

By: Ryan Carroll

The main purpose of a contract is to establish an agreement between parties to express their rights and obligations.  However, just because you may agree to something, in writing or verbally, does not mean that it will be enforceable if a legal dispute is to arise.  Two recent Massachusetts Appeals Court cases are examples of how this can work in practice.

In Goddard v. Goucher, a Massachusetts Appeals Court recently held that parties may not stipulate to legal conclusions (as opposed to factual) and that courts are not bound by these stipulations.  In this case, the parties sought to enforce a purchase and sale agreement to sell a parcel of land; never having been a final signed version of the purchase and sale agreement, they entered into pretrial stipulations that this purchase and sale agreement was a valid and enforceable contract.  At trial, the trial judge rejected the stipulation that a valid and enforceable contract was created, and the appellate court agreed.  Because the issue of whether the contract was valid is a question of law, as opposed to whether it was actually signed by parties or there was a meeting of the minds, which are factual issues that a party can stipulate to, the Court concluded that the trial judge was within his authority to reject the stipulation.

In Downey v. Chutehall Construction Co., Ltd., a Massachusetts Appeals Court recently concluded that a waiver of statutory requirements by an individual homeowner did not preclude a contractor, who violated the statute, from being liable.  In this case, the contractor alleged that the homeowner did not allow the contract to comply with state’s building code requirements relating to roofing – specifically, the contractor argued that the homeowner did not wish for the contractor to strip the existing roof materials, which was required by the code.  The contract claimed that this was a waiver by the homeowner and it was a defense to claims under Chapter 93A.  The Court concluded that the waiver did not preclude the contractor from being held liable of violations of the building code and resulting 93A violations, especially because the violation carried potential public safety concerns.  While the court did acknowledge that a statutory right or remedy may be waived if it would not frustrate the public policies of the statute, it did state that such right may not be disclaimed if the waiver could do violence to the public policy underlying the legislative enactment.

These recent cases are just examples.  There is a plethora of past cases that illustrate instances in which, despite the parties’ intents and agreements, a court could deem an entire agreement or terms contained therein, unenforceable.  That is why it is always a good idea to have legal counsel review your contracts, especially if big stakes are involved.

Tags: chapter 93A, massachusetts appeals court, stipulation, waiver

Ryan S. Carroll

On October 30, 2015, the SEC voted to adopt Regulation Crowdfunding, the final rules allowing private companies to raise capital through crowdfunding and providing additional protection to investors in crowdfunding investments.  This post provides some background on crowdfunding, a summary of Regulation Crowdfunding’s rules and forms and how we can assist in helping you in your next crowdfunding financing.  While we are lawyers, this blog is not intended to be legal advice and should not be relied on as such.  If you would like legal advice on any of the information contained in this post, please contact us.

Background on “Crowdfunding”

Crowdfunding is a new and evolving financing method that can be used to raise relatively small amounts of capital from a large number of investors at a low cost using the Internet as a means to market the offering.  Regulation Crowdfunding are the new rules which will be applicable to crowdfunding offerings relying on Section 4(a)(6) of the Securities Act of 1933 (“Securities Act”).  This Section was added by Title III of the Jumpstart Our Business Startups Act of 2012 (“JOBS Act”) which allows private companies to raise capital through new “crowdfunding” exemptions.  We last wrote on the topic of crowdfunding in this post.

Many provisions of the JOBS Act require rulemaking by the SEC.  Regulation Crowdfunding and its forms will be effective 180 days after they are published in the Federal Register (tentatively, May 2016). This will complete the SEC’s major rulemaking requirement as mandated under the JOBS Act.

The final rules can be found here.

Summary of the Rules:

The recommended rules would, among other things:

1)      Permit issuers to offer the sale of and for investors to purchase securities in crowdfunding offerings, subject to limitations.

• Such limitations on crowdfunding include:
  • the maximum aggregate amount of financing an issuer can raise through crowdfunding in a 12-month period is $1 million;
  • across all crowdfunding offerings, an individual investor, over a 12-month period may only invest, in the aggregate:\
    • the greater of $2,000 or 5% of the lesser of their annual income or net worth (if their annual income or net worth is less than $100,000); or
    • 10% of the lesser of their annual income or net worth, not to exceed $100,000 in value (if both the investor’s annual income and net worth are equal to or more than $100,000); and
  • an issuer will only be able to make an offering through a registered broker-dealer or through a funding portal and can only use one intermediary for an offering made pursuant to the exemption.

2)      Require issuers raising capital through crowdfunding to disclose certain information regarding their business and the securities being offered through Form C and other requirements.

• The initial disclosure an issuer must file about the offering is a Form C, which must be provided to the SEC, investors and the intermediary facilitating the offering.
• Information that must be disclosed on a Form C includes:
  • the price of the securities offered to the public or the method for determining the price, the target offering amount, the deadline to reach the target offering amount and whether the issuer will accept investments in excess of the target offering amount;
  • a discussion of the issuer’s financial condition, a description of the business and how the issuer plans on using the proceeds from the offering, information about the officers and directors of the issuer, information about owners of 20% or more of the issuer and certain related-party transactions; and
  • financial statements of the issuer that are accompanied by information from the issuer’s tax returns, reviewed by an independent public accountant, or audited by an independent auditor.

3)      Create a regulatory framework for intermediaries facilitating the crowdfunding transaction.

• An issuer must use a registered broker dealer or a funding portal.
• A funding portal is required to register with the SEC on new Form Funding Portal and become a member of a national securities association (currently, FINRA).
• Regulation Crowdfunding requires the registered funding portals to:
  • provide investors with educational materials that explain the process for investing on the platform, the types of securities being offered and information an issuer must provide to investors, resale restrictions and investment limits;
  • take certain measures to reduce risk of fraud by having reasonable basis for believing issuers on the platform comply with the Regulation Crowdfunding and that such issuers have a way of keeping accurate records of security holders;
  • make information that an issuer is required to disclose available to the public on its platform for a minimum of 21 days before any security may be sold and throughout the entire offering of such security; and
  • provide channels of communication for discussions about the offerings on the platform, provide disclosure to investors about compensation to the intermediary, only accept an investment commitment after such investor has opened an account, has a reasonable basis for believing an investor complies with investment limitations, provide investors notices once they made investment commitments and confirmations at or before completion of the transaction, comply with maintenance and transmission of funds requirements and comply with completion, cancellation and reconfirmation of offerings requirements.
• Regulations prohibit intermediaries to engage in certain activities, such as:
  • providing access to their platforms to issuers that they have reasonable basis for believing there is a potential for fraud or other investor protection concerns;
  • having a financial interest in an issuer where it is offering or selling securities on its platform, unless the intermediary is receiving such interest in the issuer as compensation for its services, subject to certain conditions;
  • compensating any person for providing the intermediary with personally identifiable information of any investor; and
  • offering investment advice or making recommendations, soliciting purchase, sales or offers to buy securities, compensating promoters and other solicitors, and holding possessing or handling investor funds or securities.

4)      Require issuers raising capital through crowdfunding to be subjected to ongoing reporting requirements, such as annual reports, to be filed with the SEC and provide such annual reports to investors through the intermediary.

• If an issuer is raising $100,000 or less, the following are required to be reported (among other things):
  • amount of total income, taxable income, total tax as reported on federal tax forms (if any) and financial statements of the issuer certified by the principal executive officer of the issuer.
• If an issuer is raising more than $100,000 and less than $500,000, the following are required to be reported (among other things):
  • financial statements of the issuer reviewed by an independent public accountant.
• If an issuer is raising more than $500,000, the following are required to be reported (among other things):
  • financial statements of the issuer audited by an independent public accountant.

This post is only a summary of selected sections of Regulation Crowdfunding.  Crowdfunding is a very new and nuanced form of raising capital and we recommend you contact your attorney before pursuing any such transaction.  If you have any questions concerning the information in this post, please do not hesitate to contact me at ryan.carroll@hermanlawllc.com.  

Tags: alternative financing methods, annual reports, capital, capital raise, crowdfunding, disclosure, exempt offering, Form C, funding portal, intermediaries, internet, Jobs Act, Jumpstart Our Business Startups Act, platform, registered broker-dealer, SEC, Section 4(a)(6), securities, Securities Act, Securities Act of 1933, securities exchange commission, securities regulation, Title III

The State of Delaware recently passed legislation that authorizes a statute of limitations of up to 20 years for breach of contract claims.  Delaware is the first state to adopt a statute of limitations of such length for breach of contract claims.  The legislation, which amended Section 8106 of Title 10 of the Delaware Code, was effective on August 1, 2014.  The new amended Section enables parties to a written contract involving at least $100,000 to provide that up to a twenty year limitations period will apply to any breach claims arising from the contract.

Historically, the Delaware statute of limitations for contract type claims was either three years (for general contracts) or four years (for UCC claims).  Because claims for other types of liabilities (such as say ERISA or tax claims) a buyer could be find itself liable for these third party liabilities without a remedy against a seller if the shorter limitations period had already expired.  For this reason, practitioners have tried to draft around this issue by allowing claims from certain types of reps (often referred to as the “Fundamental Representations”) to survive by contract for a longer period of time.  However, the case law on whether this actually would be enforceable has been unclear and the issue often turns on whether a contract was signed “under seal”.   While a physical seal is not necessary in Delaware, it is important to reference those key words (signed under seal, executed under seal, etc.) next to the executory signature.  Clearly a somewhat an antiquated process, and a trap for the unwary waiting to happen.

The Delaware legislature has now responded by allowing the parties to contract for this extended limitations period, without the need for the arcane “seal” language.  Now that this period is up to 20 years, the parties’ bargained-for terms will be given much greater effect under typical asset purchase or merger agreements involving the acquisition of a private company.  Since many commercial contracts also are governed by Delaware law, even where the parties are not based in Delaware, it is important to note this change for that context as well.

Although the legislation does not specifically indicate whether it would apply to contracts entered into prior to August 1, case law discussing amendments to statutes of limitations as “remedial” and not affecting “substantive or vested rights,” particularly where a statute of limitations is not shortened so as to cut off a plaintiff’s right to bring suit, suggests that this legislation should apply to contracts entered into prior to its effective date.

Tags: corporate law, corporate seal, delaware law, fundamental representations, representations and warranties, signed under seal, statute of limitations, survival period

Tags: change of stock, close corporation, closely held corporation, corporate law, cross purchase agreement, Delaware Chancery Court, delaware law, donahue v. rodd, Ehrlich, employee-shareholder, employment agreement, escrow, fiduciary duty, freeze-out, M&A, Marathon, massachusetts appeals court, Massachusetts law, massachusetts supreme judicial court, merger, minority shareholder, minority stockholder, nonsolicitation, Securities law, Selmark Associates, shareholder agreement, squeeze-out, startup, stock acquisition, stockholder agreement, venture capital

Pursuant to the Title IV of the JOBS Act, in December 2013  the SEC proposed new rules to facilitate start ups and smaller companies to raise capital.  Title IV of the JOBS Act created a new exemption under section 3(b)(2) of the Securities Act of 1933, as amended (Securities Act), for smaller offerings. As directed by section 3(b)(2), the proposed rules would amend  the existing Regulation A, an exemption for unregistered public offerings of securities up to $5 million.

These proposed rules could be significant. The amended Regulation A, commonly referred to as “Regulation A+,” is intended to facilitate capital formation for small companies by addressing certain issues in the current Regulation A that have deterred companies from using Regulation A to raise funds, including the low maximum offering amount and the high costs of state blue-sky compliance requirements.  The proposed rules would create two tiers of Regulation A offerings: Tier 1 for offerings of up to $5 million in a 12-month period and Tier 2 for offerings up to $50 million in a 12-month period.  Both tiers would be subject to certain basic eligibility, disclosure, and procedural requirements that are derived from the existing Reg A framework, with certain updates to conform to current practices for registered offerings. Tier 2 offerings would be subject to additional requirements, including the provision of audited financial statements, ongoing reporting obligations, and certain investment limitations.  Tier 2 offerings would provide federal law preemption and thus be exempt from having to comply with state blue-sky requirements.

The proposed rules are subject to a 60-day public comment period after publication in the Federal Register. If adopted, Regulation A+ has the potential to provide start-ups and private companies with a viable alternative for raising capital quickly and inexpensively, while improving the liquidity of their securities in secondary markets.  We will continue to monitor these developments and will post updates as they become available.

Tags: corporate law, Jobs Act, Regulation A, Regulations A+, SEC, securities and exchange commission, Securities law, seed investments, startup, stock, VC, venture capital

A recent decision by the Massachusetts Appeals Court interprets the right of a seller shareholder to bypass a stockholders’ representative and settle directly with a buyer claimant and to use for such settlement the proceeds from an escrow fund established as part of the sale transaction.  This opinion is an important read for anyone engaged as a stockholders representative or serves as counsel to one.   While the decision is somewhat limited by the specific provisions of the merger and escrow agreements at issue, corporate practitioners may find the facts useful for tightening up standard provisions on these issues in future deals.  The case also provides a handy explanation of the oft-used (and misunderstood) term “power coupled with an interest”, which we have summarized below.  A full copy of the opinion can be found here.

The case arises from a stock purchase merger in September 2007 of Atlantis Components, Inc. by Astra Tech, Inc.  for $71 million. Per common practice, $6.3 million of the purchase price was placed into an escrow fund, to be disbursed to the former Atlantis shareholders on a pro rata basis on December 31, 2008, the release date. The purpose of the the escrow fund was to indemnify Astra Tech if it paid any claims asserted against Atlantis after the closing date but before the release date. The merger agreement designated a Shareholder Representative as the agent of the former Atlantis shareholders, which had the duty of approving or challenging any indemnification claim on the escrow fund.

Shortly after the closing, Astra Tech brought a claim against Atlantis for failing to disclose  certain correspondence alleging that Atlantis was infringing on the patents of one its competitors.   The parties disagreed on the merits of AstraTech’s claims and various lawsuits ensued.  As legal costs for these matters ballooned to nearly $2.5 million, in October 2010 certain of the Atlantis shareholders opted to settle directly with Astra Tech, using their pro rata share of the escrow fund as payment.  After reaching an agreement, the settling shareholders and Astra Tech moved in Superior Court for approval of their settlement. The shareholders’ agent opposed the settlement, on the basis that neither the merger agreement nor the escrow agreement permitted the settling shareholders to seek disbursement absent the consent of the shareholders’ agent. A judge approved the settlement agreement between Astra Tech and the settling shareholders and this appeal followed.

The Court’s decision involved the interpretation  and interplay of three contracts between the parties: (1) the escrow agreement between Astra Tech, Atlantis, the stockholders rep, and the escrow agent; (2) the merger agreement between Astra Tech, Atlantis, and the stockholders rep; and (3) the settlement agreement between Astra Tech and the settling shareholders.

On the escrow agreement, the Court determined that that the express provisions of that Agreement did provide for a procedural mechanism to allow the settling shareholders to seek court approval of their settlement.  An excerpt of that provision is provided below for reference. (1)

On the merger agreement, the stockholders rep argued that it had the exclusive right to negotiate with Astra Tech under under Sections 8.6(a) and (e) (pasted as footnote (2) below).  While the Court agreed that these provisions granted the Stockholders Rep with broad powers to negotiate and make decisions for the settling shareholders, it held that these rights were not exclusive, which would be required to bar the settling shareholders from negotiating for themselves.  The Court refused to construe the provision that the rep’s decisions and acts “constitute a decision of all Company shareholders” and are “final, binding and conclusive upon each such Company Shareholder” as granting the rep with exclusive rights.   To create an exclusive agency, the parties must expressly and unambiguously indicate such an intent in the contract.”  The Court noted that if the parties had wished to give the shareholders’ agent the sole or exclusive authority to negotiate on behalf of the settling shareholders, they should have provided for that expressly in the contract. (“We will not contort the plain language of the merger agreement to interpret “final, binding and conclusive” as synonymous with “irrevocable” or “exclusive.”)

Finally, the stockholders rep contended that its agency was irrevocable because it has a “power coupled with an interest.”  The Court disagreed.   Despite general agency law principles (which allow a creator of the agency relationship to revoke the agent’s authority at any time, even if their agreement expressly states that the principal may not revoke), the agent’s authority can be made irrevocable when it is a “power coupled with an interest”.  The Court explained that a ”power coupled with an interest is not technically an agency relationship because “it is neither given for, nor exercised for, the benefit of the person who creates it.”  In an agency relationship, granting authority to the agent is solely for the benefit of the principal, but when a “power is coupled with an interest, the donee holds that power for his own benefit (or for the benefit of a third party), but not for the benefit of the donor.”  The reference to “interest” in this phrase means that the agent (donee of the power) must have a present interest in the property upon which the power is to operate.  It is generally accepted that the “interest” must be ownership of the property itself and it is this ownership which makes the power irrevocable.

In its analysis, the Court broke down the term “a power coupled with an interest”  into two components: first, does the agent have “a power”, and second, is the power “coupled with an interest.  On the first point, the Court held that the  rep did not have “a power” in the escrow fund, as it did not have  exclusive or irrevocable power under the merger agreement or the escrow agreement.  The rep also did not have unilateral power in the escrow fund (a distinguishing factor in other cases cited by the Court) but rather was required to reach an agreement with Astra Tech before the escrow agent could be compelled to release the funds.

On the second point, the stockholders rep did not have “an interest” in the escrow fund sufficient to create a power coupled with an interest.  Citing cases going back to 1823, the common thread requires the agent to have title or some other form of ownership of the underlying asset to assert that the power is “coupled with an interest”.   Even though the shareholders rep (as a Atlantis shareholder) had a personal interest in a portion of the escrow, it did not have a property interest in the entire fund in its capacity as shareholders’ agent.  The Court emphasized that the critical distinction between an agent and the donee of a power coupled with an interest lies in who receives the benefit of the relationship. “In a principal-agent relationship, the principal receives the benefit; for a power coupled with an interest, the benefit inures to the donee himself (or to a third party), but not to the donor.”

After concluding that the stockholders rep had neither the exclusive right to negotiate under the merger agreement nor a power coupled with an interest in the entire escrow fund, it then held that the settling shareholders did have a right to bypass the rep and enter into a direct settlement with Astra Tech.  In the absence of an agreement, the settling shareholders retain their common-law rights as principals. Notwithstanding any agreement between principal and agent, an agent’s actual authority terminates … if the principal revokes the agent’s actual authority by a manifestation to the agent. Because a principal may revoke part of the agent’s authority, it follows that a principal may, in the absence of an agreement to the contrary, negotiate on his own behalf without infringing on the agent’s ability to perform his duties.  Because nothing in the agreements abrogated these common-law rights, the Court held that the settling shareholders had the power to negotiate a settlement agreement with Astra Tech.

This opinion illustrates a number of interesting drafting points for preparing escrow and stockholder rep provisions in complex merger and sale agreements.  At the very least, practitioner may wish to counsel their clients on the alternatives of exclusive and nonexclusive roles of the rep and the possible ways those results can be effected.  Based on this decision, it appears likely that a Massachusetts court facing a similar issue will construe these agreements strictly and will require the exclusivity and revocability to be expressly stated to be enforceable.

If you have any questions regarding the issues discussed in this point, please feel free to contact us.

Footnotes:

(1) ”Any Disputed Claim and any other dispute which may arise under this Escrow Agreement with respect to the rights of [Astra Tech] or any other Indemnified Party and the Shareholders’ Agent or the Company Securityholders to the Escrow Fund shall be settled by mutual agreement of [Astra Tech] and the Shareholders’ Agent (evidenced by joint written instructions signed by [Astra Tech] and the Shareholders’ Agent and delivered to the Escrow Agent); provided, however, that upon receipt of a copy of a final and nonappealable order of a court of competent jurisdiction with respect to payment of all or any portion of the Escrow Fund, … the Escrow Agent shall deliver the portion of the Escrow Fund specified in such award or order to [Astra Tech] or other Indemnified Party and/or the Shareholders’ Agent for the benefit of the Company Securityholders as directed in such award or order.”

(2)  ”[T]he Shareholders’ Agent shall be, and hereby is, appointed and constituted in respect of each Company Securityholder, as his, her or its agent, to act in his, her or its name, place and stead, as such Company Securityholder’s attorney-in-fact, as more fully set forth in this Section 8.6. Without limiting the generality of the foregoing, the Shareholders’ Agent shall be constituted and appointed as agent for and on behalf of the Company shareholders to give and receive notices and communications, to authorize delivery to [Astra Tech] of the monies from the Escrow Fund in satisfaction of claims by [Astra Tech] Indemnified Persons against the Escrow Fund, to object to such deliveries, to agree to, negotiate, enter into settlements and compromises of, and demand arbitration and comply with orders of courts and awards of arbitrators with respect to such claims, and to take all actions necessary or appropriate in the judgment of the Shareholders’ Agent for the accomplishment of the foregoing.” [FN13]

Section 8.6(e) further delineates the actions that may be taken by the shareholders’ agent:

“A decision, act, consent or instruction of the Shareholders’ Agent shall constitute a decision of all Company shareholders … and shall be final, binding and conclusive upon each such Company shareholder, and the Escrow Agent and [Astra Tech] may rely upon any decision, act, consent or instruction of the Shareholders’ Agent as being the decision, act, consent or instruction of each and every such Company shareholder.”

Tags: acquisition, astra tech, atlantis, change of ownership, change of stock, change of stock ownership, corporate law, coupled with an interest, escrow agent, escrow agreement, escrow fund, indemnification, massachusetts appeals court, Massachusetts law, massachusetts supreme judicial court, merger, post closing liability, power coupled with an interest, reverse triangular merger, shareholder rep, shareholder representative, shareholdersrep, stock acquisition, stockholder agent, stockholder rep, stockholder representative, stockholdersrep

A recent Delaware Supreme Court decision in SIGA Technologies v. PharmAthene reaffirmed established Delaware law that an express promise to negotiate an agreement in good faith may be enforceable.   The Court also held that expectation damages may be awarded under Delaware law if a trial court can conclude that the parties would have reached an agreement but for a defendant’s bad faith.  Since term sheets are such a key part of the venture capital and M&A process, the SIGA decision illustrates the importance of carefully thinking through the details (or lack thereof) of a term sheet and their specific wording.  In particular, if at the time of a term sheet the parties are unsure of their intent, or wish to leave the negotiations open, to avoid potential damages awards appropriate disclaimers to any duty to negotiate in good faith should be included.

Of important note, in light of the SIGA decision, the Term Sheet for the NVCA Model Legal Documents has been updated to point out that the choice of law governing the term sheet should be considered more carefully.  (See footnote 1 (pasted below) to NVCA Term Sheet, found here).

If you have any questions about this topic, please feel free to email us.

Background

The SIGA decision arose in the context of negotiations between SIGA and PharmAthene (PA) relating to a potential collaboration.  At the outside of the process, SIGA was in a troubled financial state and was interested in licensing to PA rights to SIGA’s drug relating to smallpox.  While PA expressed interest in a merger, SIGA was not ready to commit to a merger process at that time.  The parties spent a number of months negotiating a detailed term sheet for a license agreement (“LATS”) which provided for a material terms, including those describing the worldwide exclusive license and sublicensing rights, various forms of upfront and milestone cash payments, funding guarantees and governance procedures. The LATS was not signed and had a footer that stated “Non Binding Terms.”

To add complexity to the matter, following the LATS, as the parties continued to negotiate, they entered into additional agreements.  PA provided SIGA with a $3 million bridge loan to provide SIGA with working capital while the merger negotiations proceeded.  The bridge loan agreement (governed by New York law) contained a provision obligating the parties to negotiate in good faith a license agreement “in accordance with the terms” set forth in the LATS if the merger were terminated.  Thereafter, SIGA and PA also into a Merger Agreement (governed by Delaware law) that contained the same provision as in the LATS requiring the parties to negotiate a license agreement in good faith in accordance with the terms LATS if the Merger Agreement were terminated.

After signing the Merger Agreement, SIGA’s financial position and prospects improved and it ultimately terminated the Merger Agreement.  While the parties then proceeded to negotiate the terms of the definitive license agreement, SIGA responded to a PA’s draft by proposing significant changes from the deal contemplated by the LATS.  The changes included a different profit splits, increased upfront payments ($100 million instead of $6 million, as specified in the LATS), and increased milestone payments ($235 million instead of $10 million, as specified in the LATS).  After SIGA conditioned any further discussions on PA’s agreement to negotiate without any preconditions regarding the binding nature of the LATS,  PA sued in the Delaware Chancery Court, asserting claims under theories of breach of contract, promissory estoppel and unjust enrichment.  After the Chancery court held in favor of PA on various grounds, SIGA appeal.

Legal Analysis

The Delaware Supreme Court held that that an express contractual obligation to negotiate in good faith is enforceable under Delaware law.  The Court affirmed the Chancery Court’s determination that SIGA acted in bad faith when it negotiated the license agreement in breach of its obligations under the Merger Agreement and the Bridge Loan Agreement.  The Court recited the standard for bad faith under Delaware law “is not simply bad judgment or negligence, but rather … the conscious doing of a wrong because of dishonest purpose or moral obliquity; it is different from the negative idea of negligence in that it contemplates a state of mind affirmatively operating with furtive design or ill will.”

Looking to precedent from both Delaware and New York, the Court reasoned that parties that bind themselves to a concededly incomplete agreement “accept a mutual commitment to negotiate together in good faith in an effort to reach final agreement within the scope that has been settled in the preliminary agreement.”  While good faith differences in the negotiation of open issues may prevent reaching a final contract, a counterparty cannot in that case insist on conditions that do not conform to the preliminary agreement.

On that basis, the Court interpreted the language “in accordance with the terms set forth [in the LATS]” to mean that the parties had a duty to “negotiate toward a license agreement with economic terms substantially similar to the terms of the LATS (or at least not inconsistent with the LATS’s terms),” as opposed to using the LATS only a “jumping off point.”  Although the LATS was not signed and had the “Non-binding” footer language, the fact that it was incorporated into the Bridge Loan Agreement and Merger was evidence of intent to negotiate toward a license agreement with substantially similar economic terms in the event the merger was not closed.

This decision also establishes that under Delaware law, contract expectation damages are an appropriate remedy where parties have preliminarily agreed to the major terms of an agreement (a Type II agreement, as discussed) and have agreed to negotiate its conclusion in good faith, and the record supports that they would have reached agreement but for bad faith.

To reach its holding, the Court looked to decisions under New York law interpreting preliminary agreements, which provide for two types of such agreements: a “Type I” agreement and a “Type II” agreement.

• A Type I agreement “is a fully binding preliminary agreement, which is created when the parties agree on all the points that require negotiation (including whether to be bound) but agree to memorialize their agreement in a more formal document. Such an agreement is fully binding….”
• A Type II agreement is where parties “agree on certain major terms, but leave other terms open for further negotiation. … — a concededly incomplete agreement accept[ing] a mutual commitment to negotiate together in good faith in an effort to reach final agreement within the scope that has been settled in the preliminary agreement.”
  • A Type II agreement “does not commit the parties to their ultimate contractual objective but rather to the obligation to negotiate the open issues in good faith in an attempt to reach the alternate objective within the agreed framework.” A Type II agreement “does not guarantee” the parties will reach agreement on a final contract because of “good faith differences in the negotiation of the open issues” may preclude final agreement. A Type II agreement “does, however, bar a party from renouncing the deal, abandoning the negotiations, or insisting on conditions that do not conform to the preliminary agreement.”
    

1.  NVCA Term Sheet FN. 1.  ”The choice of law governing a term sheet can be important because in some jurisdictions a term sheet that expressly states that it is nonbinding may nonetheless create an enforceable obligation to negotiate the terms set forth in the term sheet in good faith.  Compare SIGA Techs., Inc. v. PharmAthene, Inc., Case No. C.A. 2627 ( (Del. Supreme Court May 24, 2013) (holding that where parties agreed to negotiate in good faith in accordance with a term sheet, that obligation was enforceable notwithstanding the fact that the term sheet itself was not signed and contained a footer on each page stating “Non Binding Terms”);  EQT Infrastructure Ltd. v. Smith, 861 F. Supp. 2d 220 (S.D.N.Y. 2012); Stanford Hotels Corp. v. Potomac Creek Assocs., L.P., 18 A.3d 725 (D.C. App. 2011) with Rosenfield v. United States Trust Co., 5 N.E. 323, 326 (Mass. 1935) (“An agreement to reach an agreement is a contradiction in terms and imposes no obligation on the parties thereo.”); Martin v. Martin, 326 S.W.3d 741 (Tex. App. 2010); Va. Power Energy Mktg. v. EQT Energy, LLC, 2012 WL 2905110 (E.D. Va. July 16, 2012).  As such, because a “nonbinding” term sheet governed by the law of a jurisdiction such as Delaware, New York or the District of Columbia may in fact create an enforceable obligation to negotiate in good faith to come to agreement on the terms set forth in the term sheet, parties should give consideration to the choice of law selected to govern the term sheet.”

Tags: bad faith, expectation damages, good faith, NVCA, NVCA Model Legal Documents, NVCA model series A term sheet, preliminary agreement, promissory estoppel, Series A, Series A term sheet, term sheet