Document: Winshall v. Viacom Int’l, Inc., C.A. No. 6074-CS (Del. Ch. Nov. 10, 2011)

The Delaware Court of Chancery rejected plaintiff’s argument that both the seller and the acquirer of a business possessed an affirmative duty under the implied covenant of good faith and fair dealing to take an opportunity to increase the potential earn-out payments to the seller’s stockholders under a merger agreement in which the stockholders possessed no reasonable expectancy interest.

In 2006, defendant Viacom International (“Viacom”) acquired defendant Harmonix Music Systems, Inc., a creator of music-oriented gaming systems (“Harmonix”).  Under a merger agreement entered into among Viacom, Harmonix and certain Harmonix stockholders in 2006, Harmonix’s stockholders were entitled to receive an up-front cash payment for their shares, as well as a contingent right to receive uncapped earn-out payments based on Harmonix’s financial performance in the two years following the merger, 2007 and 2008.  About one year after the merger closed, Harmonix released a new video game, which was very successful, and Harmonix renegotiated an existing contract it had with a third party for the distribution of the game.  As part of the renegotiation, Harmonix was able to obtain a wider distribution of its product and a reduction in distribution fees, in upcoming years, following the expiration of the earn-out period.

In this action, plaintiff alleged that the defendants breached the implied covenant of good faith and fair dealing by not negotiating for a reduction in distribution fees during the earn-out period.  The Court found inequitable the proposed imposition of a duty on the defendants to share with Harmonix’s stockholder the benefits of a renegotiated contract addressing distribution rights after the expiration of the earn-out period.  According to the Court, the implied covenant of good faith and fair dealing requires a party to refrain from conduct that is contrary to the fundamental expectations of the other party as implied by the explicit terms of the deal.  In this case, plaintiff sought to actually expand “its contractual counterparty’s expectancy as a matter of judicially compelled charity, not toward a 501(c)(3), but toward another sophisticated commercial actor.”  Slip. Op. at 21.  Accordingly, the Court dismissed plaintiff’s complaint.