Winshall v. Viacom Int’l Inc., C.A. No. No. 39, 2013 (Del. Oct 7, 2013)

In this opinion, the Supreme Court of the State of Delaware affirmed the Court of Chancery’s judgment granting the defendants’ motion to dismiss for failure to state a claim upon which relief can be granted, rejecting a claim by a stockholder representative that the parties to a merger agreement breached the implied covenant of good faith and fair dealing by failing to take certain actions after the closing of the merger that would have the effect of increasing the earn-out payments due to the former stockholders of the target corporation.  The Supreme Court also affirmed the Court of Chancery’s judgment granting the stockholder representative’s motion for summary judgment, (i) holding that the stockholders were not required to indemnify the acquirer for alleged breaches of representations and warranties contained in the merger agreement and (ii) ordering payment of the escrowed portion of the merger cash consideration owed by the acquirer to the stockholders.

In 2006, defendant Viacom International Inc. (“Viacom”) entered into an agreement (the “Merger Agreement”) to buy defendant Harmonix Music Systems, Inc. (“Harmonix”), a developer of music-themed video games, including Rock Band.  The Merger Agreement contained a provision granting a contingent right to Harmonix stockholders to receive uncapped earn-out payments based on Harmonix’s financial performance in 2007 and 2008.  The Merger Agreement also provided that the selling stockholders would indemnify Viacom against losses arising out of the breach of representations and warranties in the Merger Agreement.  Under a separate agreement, the parties agreed to deposit $12 million of the purchase price into escrow to be used, among other things, to indemnify Viacom.  In 2007, Harmonix, now a subsidiary of Viacom, entered into a distribution agreement with Electronic Arts (“EA”) for the distribution of Rock Band through 2010 (the “Original EA Agreement”).  In 2008, following the immediate success of Rock Band, EA and Harmonix entered into an amended licensing agreement (the “Amended EA Agreement”) that allowed EA broader distribution rights to future sequels and to distribute Rock Band for the same fees in 2008 in exchange for, among other things, reduced distribution fees after 2008.

On April 24, 2008, three days before the deadline for giving notice of claims under the Merger Agreement, Viacom gave the stockholder representative, Walter Winshall, notice that it might seek indemnification for three claims against it for violations of intellectual property related to Rock Band.  On July 21, 2008, almost three months after the deadline, Viacom gave Winshall notice of a fourth claim. 

In December 2010, Winshall filed suit in the Court of Chancery.  Count I of Winshall’s complaint alleged that Viacom and Harmonix breached the implied covenant of good faith and fair dealing inherent in the Merger Agreement by intentionally deferring the distribution discount until after the expiration of the earn-out period. Counts II and III sought declaratory relief that Viacom was not entitled to indemnification and an order requiring Viacom to release the escrow funds to the selling stockholders. In an opinion dated November 10, 2011, the Court of Chancery granted defendants motion to dismiss Count I for failure to state a claim upon which relief could be granted.  In an opinion dated December 12, 2012, the Court of Chancery granted summary judgment for Winshall on Counts II and III.  Both sides appealed.

On appeal, the Delaware Supreme Court first reviewed the Court of Chancery’s dismissal of Count I of Plaintiff’s complaint.  In a lengthy footnote, the Supreme Court reiterated its holding in Central Mortg. Co. v. Morgan Stanley Mortg. Capital Holdings LLC that the standard of review on a motion dismiss is whether the complaint states a cognizable claim under any “reasonably conceivable” set of circumstances – a less rigorous standard than the “plausibility” standard adopted by federal courts.  Reviewing the trial court’s decision de novo and applying the reasonable conceivability standard, the Supreme Court affirmed both the Court of Chancery’s rejection of Winshall’s claim and, among other things, its determinations that (i) nothing in the Merger Agreement could be read to imply that Viacom and Harmonix must conduct their businesses after the merger in a manner that maximizes the earn-out payments, (ii) Viacom and Harmonix did not take any action to increase the 2008 distribution fees beyond what was expected in the Original EA Agreement, and (iii) Viacom and Harmonix had no obligation to renegotiate the Original EA Agreement to increase the amount of the stockholders’ earn-out payments, just because an opportunity had been presented.

The Supreme Court then addressed Viacom’s cross-appeal, which claimed that the Court of Chancery reversibly erred in granting summary judgment to Winshall on Counts II and III.  Before doing so, however, the Court took the opportunity, in another lengthy footnote, to reaffirm that “[a]n appellee who does not file a cross-appeal may defend the judgment with any argument that is supported by the record, even if it questions the trial court’s reasoning . . . .”  To the extent the Supreme Court’s recent opinion in Gerber v. Enterprise Products Holdings, LLC suggested that all aspects of a trial judge’s reasoning are unalterable unless the victorious appellee files a cross appeal, the Supreme Court overruled Gerber.

As to Viacom’s cross-appeal, the Court reviewed the trial court decision granting summary judgment de novo.  The Court first affirmed the Court of Chancery’s rejection of Viacom’s argument that the selling stockholders were responsible for paying Viacom’s defense costs associated with the four claims brought against it for violations of intellectual property, even if there was no breach of a representation or warranty.  Upon assessing the relevant provisions, the Supreme Court agreed that the Merger Agreement did not impose any independent duty to pay defense costs, in the absence of a breach of an underlying representation or warranty.  The Supreme Court also concluded that the Court of Chancery committed no error, and ruled correctly, in holding that Viacom had failed to demonstrate any breach of a representation or warranty and granting summary judgment to Winshall on Counts II and III.

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