Opinion ID: 1952344
Heading Depth: 1
Heading Rank: 4

Heading: Analyzing the Validity of Liquidated Damages

Text: In Lee Builders v. Wells , a case involving a liquidated damages provision equal to 5% of the purchase price in a contract for the sale of land, the Court of Chancery articulated the following two-prong test for analyzing the validity of the amount of liquidated damages: Where the damages are uncertain and the amount agreed upon is reasonable, such an agreement will not be disturbed. [12] Plaintiff argues that the termination fee, if properly analyzed as liquidated damages, fails the Lee Builders test because both portions of the fee are punitive rather than compensatory, having nothing to do with actual damages but instead being designed to punish Bell Atlantic stockholders and the subsequent third-party acquirer if Bell Atlantic were ultimately to agree to merge with another entity. We find, however, that the termination fee safely passes both prongs of the Lee Builders test. To be a valid liquidated damages provision under the first prong of the test, the damages that would result from a breach of the merger agreement must be uncertain or incapable of accurate calculation. Plaintiff does not attack the fee on this ground. Given the volatility and uncertainty in the telecommunications industry due to enactment of the Telecommunications Act of 1996 and the fast pace of technological change, one is led ineluctably to the conclusion that advance calculation of actual damages in this case approaches near impossibility. Plaintiff contends, however, that the $550 million fee violates the second prong of the Lee Builders test, i.e., that it is not a reasonable forecast of actual damages, but rather a penalty intended to punish the stockholders of Bell Atlantic for not approving the merger. Plaintiff's attack is without force. Two factors are relevant to a determination of whether the amount fixed as liquidated damages is reasonable. The first factor is the anticipated loss by either party should the merger not occur. The second factor is the difficulty of calculating that loss: the greater the difficulty, the easier it is to show that the amount fixed was reasonable. [13] In fact, where the level of uncertainty surrounding a given transaction is high, [e]xperience has shown that ... the award of a court or jury is no more likely to be exact compensation than is the advance estimate of the parties themselves. [14] Thus, to fail the second prong of Lee Builders, the amount at issue must be unconscionable [15] or not rationally related to any measure of damages a party might conceivably sustain. [16] Here, in the face of significant uncertainty, Bell Atlantic and NYNEX negotiated a fee amount and a fee structure that take into account the following: (a) the lost opportunity costs associated with a contract to deal exclusively with each other; (b) the expenses incurred during the course of negotiating the transaction; (c) the likelihood of a higher bid emerging for the acquisition of either party; and (d) the size of termination fees in other merger transactions. The parties then settled on the $550 million fee as reasonable given these factors. Moreover, the $550 million fee represents 2% of Bell Atlantic's market capitalization of $28 billion. This percentage falls well within the range of termination fees upheld as reasonable by the courts of this State. [17] We hold that it is within a range of reasonableness and is not a penalty. This is not strictly a business judgment rule case. If it were, the Court would not be applying a reasonableness test. The business judgment rule is a presumption that directors are acting independently, in good faith and with due care in making a business decision. It applies when that decision is questioned and the analysis is primarily a process inquiry. [18] Courts give deference to directors' decisions reached by a proper process, and do not apply an objective reasonableness test in such a case to examine the wisdom of the decision itself. [19] Since we are applying the liquidated damages rubric, and not the business judgment rule, it is appropriate to apply a reasonableness test, which in some respects is analogous to some of the heightened scrutiny processes employed by our courts in certain other contexts. Even then, courts will not substitute their business judgment for that of the directors, but will examine the decision to assure that it is, on balance, within a range of reasonableness. [20] Is the liquidated damages provision here within the range of reasonableness? We believe that it is, given the undisputed record showing the size of the transaction, the analysis of the parties concerning lost opportunity costs, other expenses and the arms-length negotiations. Plaintiff further argues that the termination fee provision was coercive. Plaintiff contends that (a) the stockholders never had an option to consider the merger agreement without the fee, and (b) regardless of what the stockholders thought of the merits of the transaction, the stockholders knew that if they voted against the transaction, they might well be imposing a $550 million penalty on their company. Plaintiff contends that the termination fee was so enormous that it influenced the vote. Finally, plaintiff argues that the fee provision was meant to be coercive because the drafters deliberately crafted the termination fees to make them applicable when Bell Atlantic's stockholders decline to approve the transaction as opposed to a termination resulting from causes other than the non-approval of the Bell Atlantic stockholders. We find plaintiff's arguments unpersuasive. First, the Court of Chancery properly found that the termination fee was not egregiously large. Second, the mere fact that the stockholders knew that voting to disapprove the merger may result in activation of the termination fee does not by itself constitute stockholder coercion. Third, we find no authority to support plaintiff's proposition that a fee is coercive because it can be triggered upon stockholder disapproval of the merger agreement, but not upon the occurrence of other events resulting in termination of the agreement. In Williams v. Geier , this Court enunciated the test for stockholder coercion. Wrongful coercion that nullifies a stockholder vote may exist where the board or some other party takes actions which have the effect of causing the stockholders to vote in favor of the proposed transaction for some reason other than the merits of that transaction. [21] But we also stated in Williams v. Geier that [i]n the final analysis ... the determination of whether a particular stockholder vote has been robbed of its effectiveness by impermissible coercion depends on the facts of the case. [22] In this case, the proxy materials sent to stockholders described very clearly the terms of the termination fee. Since the termination fee was a valid, enforceable part of the merger agreement, disclosure of the fee provision to stockholders was proper and necessary. [23] Plaintiff has not produced any evidence to show that the stockholders were forced into voting for the merger for reasons other than the merits of the transaction. To the contrary, it appears that the reciprocal termination fee provisions, drafted to protect both Bell Atlantic and NYNEX in the event the merger was not consummated, were an integral part of the merits of the transaction. Thus, we agree with the finding of the Court of Chancery that, although the termination fee provision may have influenced the stockholder vote, there were no structurally or situationally coercive factors that made an otherwise valid fee provision impermissibly coercive in this setting. [24]