Jenna Muttik
Staff Editor, Delaware Journal of Corporate Law, Volume 50
I. Introduction
In a society that relies on contracts, it is common for individuals who are not parties to a contract to attempt to enforce it when it is intended to benefit them. Meanwhile, contractual privity is a staple of contract law: only parties to a contract have standing to enforce the contract’s terms.[1] Nevertheless, contract law carves out exceptions and allows certain third parties to have standing to bring a claim when they are “intended” to benefit from the contract.[2] However, this area gets more complex depending on the contract’s language and in consideration of public policy to limit the access of third-party beneficiary standing. Thus, this blog will assess how Delaware courts treat the necessary limit of third-party beneficiary standing and its policy considerations in the realm of shareholders.
II. General Policy of Limiting Shareholder Third-Party Beneficiary Standing in the View of Delaware Courts
Delaware courts typically resist granting shareholders third-party standing to enforce corporate contracts.[3] This resistance primarily revolves around Delaware’s board-centric model, prioritizing the board of directors’ decision-making ability.[4] As a result of this board-centric model, a less limited approach to third party standing of shareholders would run afoul of this model by allowing shareholders to encroach on the board’s decision-making authority. [5] Additionally, in a practical sense, a less limited position would open the floodgates to shareholder suits, leading to increased litigation costs for corporations.[6]
Merger agreements are examples of contracts where third-party beneficiary issues may arise as they typically include provisions specifically benefitting shareholders.[7] These agreements are unique in this third-party beneficiary policy issue since shareholders are, without a doubt, intended economic beneficiaries of the merger; the agreement’s purpose is to deliver the payment of consideration to the target company’s shareholders.[8] The policy of limiting third-party standing for shareholders in merger agreements differs in that there is not the same issue of standing implicating the demand requirement.[9] However, Delaware courts double down in that third-party beneficiary standing should not be granted because it encroaches on the board-centric model.[10]
III. Contract Formation’s Role in Third-Party Beneficiary Standing for Shareholders
Despite the resistance, looking within the contract’s four corners is significant in determining whether the court would extend third-party standing to shareholders. Commonly, there are “no-third-party-beneficiaries” provisions: an express provision disclaiming an intent of the contracting parties to convey third-party-beneficiary standing.[11] Although Delaware courts give these provisions significant weight, they can be overcome when the contract includes more specific language demonstrating, contrary to the provision, an intent to benefit a third party.[12] Delaware courts recognize a strong intent to disclaim third-party beneficiaries when there are customized carve-outs, demonstrating “that the parties knew how to confer third-party beneficiary status and deliberately chose not to do so with respect to any unlisted groups.”[13] In Crispo v. Musk, the Delaware Court of Chancery found that the plaintiff, a shareholder, did not have third-party standing because the Merger Agreement had a “No-Third-Party-Beneficiaries” provision which contained three custom carve-outs, demonstrating a strong intent to disclaim third-party-beneficiary standing.[14]
However, there is a path for shareholders to have redress if a buyer breaches a merger agreement: lost-premium provisions. The most common lost-premium provision generally includes negotiated lost shareholder premiums within a target company’s damages, allowing target companies to claim damages against a buyer for breach of the merger agreement.[15] Crispo v. Musk found these provisions to be unenforceable illegal penalty clauses since the target company has no expectation interest in receiving merger consideration.[16] However, with the implications of this decision, including the risk of more breaches and lack of accountability with trivial damage awards, the Delaware General Assembly amended Section 261 of the Delaware General Corporation Law, effective August 1, 2024, to restore lost premium provisions.[17] With the addition of Section 261(a)(1), a target company may include a provision in a merger agreement allowing them to seek damages, including shareholder lost premium damages, against a buyer that has breached.[18] Meanwhile, Section 261(a)(2) added that shareholders may appoint a representative in a merger agreement to enforce shareholder rights to payment of merger consideration.[19]
IV. Save Yourself with Proper Drafting of “No-Third-Party-Beneficiaries” or “Lost-Premium” Provisions
Proper drafting of a merger agreement can save companies future litigation costs, and can avoid major headaches down the road. In drafting “no-third-party-beneficiaries” clauses, drafters should utilize specific language and customized carve-outs to demonstrate a strong intent to disclaim third-party beneficiary status. Additionally, the resistance to granting shareholders third-party standing in corporate contracts, like merger agreements, does not entirely prohibit their redress for a buyer’s breach as lost-premium provisions are there to help and have been restored by the 2024 amendments to Section 261.
About the Author
Jenna is a second-year law student at Widener University Delaware Law School. She serves as a Staff Editor and Junior Manuscript Editor for the 50th Volume of the Delaware Journal of Corporate Law. She is the incoming Internal Managing Editor for Volume 51 of the Delaware Journal of Corporate Law. She graduated from Immaculata University in 2024, earning her bachelor’s degree, summa cum laude,in Criminology, and participated in their 3+3 program with Widener University Delaware Law School. Jenna is interested in various practice areas and plans to take the Pennsylvania and Delaware bar exam.
[1] Faola Divine Bright, The Doctrine of Privity of Contract: Legal Foundations and Modern Exceptions (October 6, 2024), http://dx.doi.org/10.2139/ssrn.4977295.
[2] See Restatement (Second) of Contracts § 302 (Am. L. Inst. 1981).
[3] Crispo v. Musk, 304 A.3d 567, 575 (Del. Ch. 2023).
[4] Crispo, 304 A.3d at 576; see Del. Code Ann. tit. 8, § 141(a) (2020) (“The business and affairs of every corporation . . . shall be managed by or under the direction of a board of directors . . . .”).
[5] Crispo, 304 A.3d at 576.
[6] Id. at 576.
[7] See Paula M. Bagger, Third-Party Contract Beneficiaries: What Did the Parties Intend? A.B.A. (Jan 20, 2020), https://www.americanbar.org/groups/litigation/resources/newsletters/commercial-business/third-party-contract-beneficiaries-what-did-parties-intend/; See also Del. Code Ann. tit. 8, §§ 251, 259 (2020).
[8] Jonathan Chan & Martin Petrin, Lost-Premium Damages in M&A: Delaware’s New Legal Landscape, Yale J. on Reg. Bull. at 2 (forthcoming Aug. 2024), http://dx.doi.org/10.2139/ssrn.4920293.
[9] Crispo, 304 A.3d at 577.
[10] Id.
[11] Id. at 574.
[12] Id. at 575.
[13] Crispo, 304 A.3d at 575.
[14] Id. at 578.
[15] Chan & Petrin, supra note 8, at 6.
[16] Id. (citing Crispo, 304 A.3d at 582-84); see Crispo, 304 A.3d at 584 (elaborating that only shareholders expect a premium so lost-premium provisions are only enforceable if the provision grants shareholders third-party beneficiary status).
[17] Chan & Petrin, supra note 8, at 3; see also Del. Code Ann. tit. 8, § 261(a)(1)–(2) (2024).
[18] See § 251(a)(2); see also Chan & Petrin, supra note 8, at 7.
[19] See § 251(a)(1); see also Chan & Petrin, supra note 8, at 7.
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