Buyer is a company headquartered in Boulder, Colorado. Buyer is a publicly traded company that provides high-capacity dark fiber, wavelength, IT infrastructure services and ethernet products and services. Since its founding, it has made forty-one acquisitions of fiber and data center companies, averaging about three to four acquisitions per year.
Denver area-based Seller was a founded in late 2007. Before the execution of the stock purchase agreement, Seller owned all of the issued and outstanding stock of 3 subsidiaries (collectively, Target). At the time of the acquisition, Seller, through Target, offered a collection of IT infrastructure services, including data center colocation services, managed hosting services, and enterprise and public cloud services. It operated out of eight data centers in the United States, as well as a cloud storage platform in London.
Target’s customers’ needs naturally fluctuated over the duration of their relationship with Target. It was common for customers to require less storage space after they developed their own ability to perform the functions they had relied on Target to provide. As the expiration of their Target contract term approached, Target customers routinely would negotiate new contracts with Target on more favorable terms. More-for-less was the mantra that Target sales force regularly confronted as customer contracts expired.
Target always aimed to renew customer contracts in order to lock down the resulting cash flow. With market prices declining, however, Target often needed to make concessions in order to keep customers. This meant that Target would have to accept either pricing discounts in return for restored space or a longer contract term. While not optimal, this strategy eventually created more guaranteed revenue.
Seller’s investors and the Seller board of directors decided by late spring 2014 that it was appropriate to consider strategic alternatives for Seller, including a sale of Target.
The day before Christmas Eve, 2014, Buyer sent Seller a letter of intent proposing to buy the Target stock. This proposal included a stock purchase agreement mark-up of Seller’s original draft.
Buyer proposed in its revised draft stock purchase agreement that Seller disclose any major Target customers that had given notice of nonrenewal of their Target contracts. Seller would not accept this language and Buyer let it go.
Buyer and Seller executed the stock purchase agreement on January 13, 2015, which provided for a $675 million purchase price. Buyer’s acquisition of the Target stock closed on February 23, 2015.
Buyer’s problems with the deal surfaced after the closing. Buyer was disappointed with Target’s post-closing performance. Buyer believed this was partly caused by 5 Target customers who had notified Seller before the closing that they were not going to renew their Target contracts or renew on less favorable terms. This was information that Seller never disclosed to Buyer before the closing.
Buyer sued Seller in a Delaware state court, claiming that Seller was obligated by the stock purchase agreement to disclose this information; specifically pointing to Seller’s representation and warranty provision that required Seller to disclose to Buyer any Target customer that was cancelling, terminating, materially modifying or refusing to perform a material contract.
The court did not buy the argument. The court said that the Seller representation and warranty requiring Seller to disclose to Buyer any Target customer termination, cancellation, or refusal to perform a material contract could require Seller to disclose to Buyer any customer that expressed an intent not to renew its Target contract, and that materially modify could include any customer that expressed an intent to negotiate for new terms in its Target contract.
On the other hand, the Seller representation and warranty requiring Seller to disclose any customer termination, cancellation, or refusal to perform a material contract could obligate Seller to disclose to Buyer only when a customer ends, or expresses an intent to end, a contract before the expiration of the contract’s current, non-renewed term, and “materially modify” could apply only to modifications of an existing contract as opposed to a potentially renewed contract.
Thus, the court concluded that the language was ambiguous and so it looked to the behavior of Buyer and Seller on the subject that occurred before the dispute broke out to see how they interpreted the provision. And that was bad for Buyer because Buyer had tried to include language in the stock purchase agreement requiring Seller to disclose any notice Target had received that a customer was not going to renew a material Target contract. The court said that Buyer would not have asked for this language, (which was rejected by Seller), unless Buyer thought that the disclosure of contract cancellations, terminations, or modifications did not cover contract nonrenewals.
The result: Buyer could not sue Seller for not disclosing the nonrenewals.
This case is referred to as Zayo Group, LLC v. Latisys Holdings, LLC, C.A. No. 12874-VCS, Court of Chancery of Delaware, (Decided: November 26, 2018).
Comment. The outcome does not seem fair. Buyer wanted Seller to tell it about pending nonrenewals. Seller refused even though Seller knew about renewals. Buyer closed, and Buyer finds out post-closing about the nonrenewals, and the resulting drop in value of Target.
Nevertheless, Buyer could not do anything about it unless Buyer’s nonrenewal language had been in the stock purchase agreement. As the court said, without an express Seller representation about nonrenewals buyer was accepting the risk that there were nonrenewals of material contracts.
By John McCauley: I help people start, grow, buy and sell their businesses.
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