Business Vantage Point Blog

A recent decision by the Delaware Supreme Court emphasizes the importance of clearly written notice provisions in a contract and strict compliance with them, including any timing requirements and provisions requiring the disclosure of information and documents as a condition to a valid notice.

What the Chancery Court Found

In Thompson Street Capital Partners IV v. Sonova United States Hearing Instruments, Sonova United States Hearing Instruments LLC acquired audiology practices operated by Alpaca Group Holdings LLC pursuant to a merger agreement entered into by, among others, Alpaca, Sonova and Thompson Street Capital Partners IV LP, the latter of which served as the representative of former members of Alpaca. One business day before the survival period for submitting certain claims for indemnification under the merger agreement expired, Sonova delivered a notice (claim notice) to Thompson, as members’ representative, in which Sonova claimed indemnification for breaches of certain representations and warranties under the merger agreement based upon alleged improper billing practices of Alpaca, its affiliates and the audiology practices.

The claim notice stated that Sonova became aware of certain billing practices of Alpaca and its affiliates that Sonova believed were not in compliance with applicable laws and/or third-party payor reimbursement rules or other requirements, and as a result of such billing practices, Sonova believed Alpaca and its affiliates billed and received payment or reimbursement to which they are not entitled, which constituted the breach of certain representations and warranties under the merger agreement. The claim notice also stated that Sonova’s investigation and analysis was continuing, and that it would supplement the claim notice as it learned additional information. The claim notice alleged that, while the aggregate amount of damages was not known or estimable with certainty, such damages exceeded the funds that were deposited and held in escrow to provide a source of funds for indemnification claims, and directed the escrow agent to reserve the full amount of the escrow.

Thompson filed a complaint in the Delaware Court of Chancery, seeking an order declaring that Sonova’s claim notice did not comply with contractual requirements under the merger agreement because, among other things: (1) it was not delivered within 30 days of Sonova becoming aware of the claim as required by the merger agreement; and (2) it did not include the specific information required under the merger agreement, including a description of the claim in reasonable detail and “all available material written evidence thereof.” Thompson sought a mandatory injunction requiring Sonova to execute a joint instruction letter directing the escrow agent to release the funds in escrow to Thompson in its capacity as members’ representative.

Sonova moved to dismiss the action, arguing that: the merger agreement required only that it serve a written claim notice on or before the survival date in order to preserve a claim for indemnification and prevent the release of the escrowed funds and did not contemplate the level of detail that Thompson was seeking; the claim notice was timely; and Thompson did not plead any specific prejudice or harm due to the timing of claim notice.

The Chancery Court granted Sonova’s motion to dismiss the action, finding that Sonova’s claim notice was valid for stopping the release of the escrowed funds. Thompson appealed to the Delaware Supreme Court.

What the Supreme Court Found

On appeal, the state Supreme Court reversed the Court of Chancery’s dismissal of the action and remanded the action for further development of certain points.

Failure to Provide All Required Information in Notice

The Supreme Court held that it is reasonably conceivable that Sonova failed to comply with the requirement in the merger agreement that Sonova include copies of all available material written evidence of its claim, noting the complaint alleged that although Sonova supposedly spent months investigating and analyzing these matters, Sonova’s claim notice failed to include any materials or evidence supporting Sonova’s claim, let alone copies of “all available material written evidence thereof” as required by the merger agreement.

Failure to Comply with Timing Requirement

The court also held that it is reasonably conceivable that Sonova violated the provision in the merger agreement requiring Sonova to provide notice of its claim within the specified time period. The court found that Thompson adequately pleaded that (1) Sonova failed to provide notice of its claim within the required time period and (2) the delay actually and materially prejudices the merger party, to the extent sufficient to survive a motion to dismiss. The court noted that Thompson’s complaint alleged that Sonova had been aware of the facts underlying the claim since long before the date it delivered the claim notice, as Sonova representatives confirmed in various communications with Alpaca’s former CEO and CFO before the merger agreement closed, as well as in communications with a continuing employee of Sonova following the closing.

The court also noted that Thompson pleaded that by disregarding the claim deadline Sonova caused the kind of material prejudice that deadline was put in place to avoid, including by: (1) increasing the risk of excess damages by disregarding contractual and statutory refund/repayment periods; (2) negating the parties’ ability to negotiate with applicable third-party payors in good faith and in a timely manner where due credit would be given; and (3) potentially implicating a greater period of noncompliance in any final damages.

Waiver/Forfeiture of Sonova’s Ability to Claim Indemnification

Thompson argued that Sonova’s failure to comply with each of the requirements in the merger agreement applicable to asserting a claim for indemnification resulted in an enforceable waiver/forfeiture of Sonova’s ability to seek indemnification.

In its analysis, the court reviewed a number of Delaware cases that it found distinguishable from this case and noted that if the language of a contract does not clearly provide for forfeiture, a court will construe the contract to avoid causing one. In this case, the court found that the merger agreement provides that Sonova shall have no right to recover any amounts pursuant to the agreement unless Sonova notifies the members’ representative in writing of such claim on or before the survival date. The court held that such language unambiguously expressed a condition precedent capable of triggering a forfeiture due to Sonova’s noncompliance with notice requirements.

The court remanded the action for further proceedings consistent with its opinion, including whether the forfeiture from noncompliance with the condition precedent can be excused based upon questions of materiality and disproportionate forfeiture that are insufficiently developed in the record.