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Winshall v. Viacom Intern., Inc.

Supreme Court of Delaware

October 7, 2013

Walter A. WINSHALL, in his capacity as the Stockholders' Representative, Plaintiff Below, Appellant, Cross Appellee,
v.
VIACOM INTERNATIONAL INC., and Harmonix Music Systems, Inc., Defendants Below, Appellees, Cross Appellants.

Submitted: July 10, 2013.

Corrected: Oct. 8, 2013.

Page 809

[Copyrighted Material Omitted]

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Court Below: Chancery Court of the State of Delaware, C.A. No. 6074.

Upon appeal from the Court of Chancery. AFFIRMED.

Gregory V. Varallo, Esquire, Scott W. Perkins, Esquire, and Robert L. Burns, Esquire, Richards, Layton & Finger, P.A., Wilmington, Delaware; William B. Chandler, III, Esquire and Ian R. Liston, Esquire, Wilson Sonsini Goodrich & Rosati, Georgetown, Delaware; Of Counsel: Shawn J. Rabin, Esquire (argued) and Neal S. Manne, Esquire, Susman Godfrey LLP, New York, New York; and David M. Schiffman, Esquire (argued), Linton J. Childs, Esquire, Sidley Austin LLP, Chicago, Illinois, for Appellant, Cross Appellee.

Stephen P. Lamb, Esquire, Paul, Weiss, Rifkind, Wharton & Garrison LLP, Wilmington, Delaware; Of Counsel: Leslie G. Fagen, Esquire, Daniel J. Leffell, Esquire, Robert A. Atkins, Esquire (argued), and Steven C. Herzog, Esquire, Paul, Weiss, Rifkind, Wharton & Garrison LLP, New York, New York, for Appellees, Cross Appellants.

Before STEELE, Chief Justice, BERGER, JACOBS, and, RIDGELY, Justices, and VAUGHN, President Judge,[*] constituting the Court en Banc.

JACOBS, Justice.

Pending before us are cross-appeals from a judgment of the Court of Chancery in an action brought by Walter A. Winshall (" Winshall" ), as representative of the former stockholders (the " Selling Shareholders" ) of Harmonix Music Systems, Inc. (" Harmonix" ). The dispute arose out of a merger in 2006 (the " Merger" ), wherein Harmonix was acquired by Viacom International, Inc. (" Viacom" ). For the reasons stated in its opinions issued on November 10, 2011 [1] and December 12, 2012,[2] the Court of Chancery: (1) dismissed Winshall's complaint against Viacom and Harmonix for failure to state a legally cognizable claim for relief, (2) declared that Viacom was not entitled to indemnification from the Selling Shareholders for alleged breaches of representations and warranties contained in the Merger Agreement, and (3) ordered payment of the escrowed portion of the Merger cash consideration owed by Viacom to the Selling Shareholders.

Winshall appealed to this Court from the portion of the final judgment dismissing Count I of his complaint. Viacom cross-appealed from that portion of the judgment relating to Counts II and III of the complaint, in which the court determined that Viacom was not entitled to indemnification and directed that the escrowed funds be paid to the Selling Shareholders. For the reasons next discussed, we affirm the judgment of the Court of Chancery in its entirety.

FACTS

The facts are drawn from the amended complaint, as recited by the Court of Chancery in its two opinions. Viacom is a global entertainment company whose portfolio of television, motion picture and digital media brands includes MTV, BET Networks and Paramount Pictures. Harmonix

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is a developer of music-oriented video games, including Guitar Hero and Rock Band. [3]

In 2006, Viacom acquired Harmonix in the Merger in which Harmonix became a wholly owned subsidiary of Viacom. The critical terms of that transaction were embodied in a merger agreement dated September 20, 2006 (" Merger Agreement" ) and in an escrow agreement dated October 27, 2006 (" Escrow Agreement" ). Plaintiff Winshall was the designated representative of the Selling Shareholders, who are the former holders of Harmonix stock, options and warrants.

Under the Merger Agreement, Viacom agreed to pay the Selling Shareholders two forms of consideration: (1) a $175 million cash payment payable at closing, plus (2) a contingent right to receive incremental uncapped earn-out payments, based on Harmonix's financial performance, during the two years after the Merger, i.e., 2007 and 2008. Those contingent payments were equal to 3.5 times the amount by which Harmonix's Gross Profit (as defined by the Merger Agreement) [4] exceeded $32 million in 2007 and $45 million in 2008. The Merger Agreement did not require Viacom or Harmonix [5] to conduct their businesses, postmerger, so as to ensure or maximize the earn-out payments.

The Merger Agreement and Escrow Agreement also provided that the Selling Shareholders shall indemnify and reimburse Viacom for certain losses, including the costs of defending against third-party claims arising out of a breach of representations and warranties in the Merger Agreement. Those agreements further provided that, for a period of 18 months, $12 million of the initial $175 million payment would be held in escrow and made available to satisfy those indemnification obligations. The Selling Shareholders were obligated, however, to indemnify Viacom against any covered liabilities above the escrowed $12 million, from the monies otherwise payable under the earn-out provisions.

By the time the Merger closed in October 2006, Harmonix was engaged in developing a new video game, Rock Band. Six months later, in March 2007 and before the development of Rock Band was complete, Harmonix entered into an agreement (the " Original EA Agreement" ) with Electronic Arts, Inc. (" EA" ) to distribute Rock Band in exchange for the payment to EA of distribution fees (the " distribution fee" ). The distribution fee to EA turned out to be an important component of the Merger Agreement formula for calculating the earn-out payments to the Selling Shareholders, because it was one of the largest single postmerger expenses that Harmonix incurred. The amended complaint alleges that the huge and immediate success of Rock Band threatened to cause a surge in the 2008 earn-out payment which, in turn, gave the Defendants bargaining leverage to renegotiate the Original EA Agreement.

In October 2008, EA and Harmonix entered into an amended licensing agreement

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(the " Amended EA Agreement" ) that extended the term of the Original EA Agreement, and also expanded EA's right to distribute additional games, such as The Beatles: Rock Band, that were not covered by the Original EA Agreement.[6] During the negotiations, (the amended complaint alleges) EA offered to reduce the 2008 distribution fees payable by Harmonix (now a Viacom subsidiary) in exchange for receiving other, separate benefits. Ultimately, the Defendants did not accept that proposal. Instead, the Amended EA Agreement left the 2008 distribution fee level unchanged, and reduced the distribution fees for years beginning in 2009, in return for (among other things) commitments by EA to purchase advertising from MTV Networks and other Viacom outlets. The Amended EA Agreement also accelerated into 2008 certain payments due to Harmonix from EA that would otherwise have been paid in January and February 2009. Importantly, none of those amendments affected in any way the Selling Shareholders' earn-out payment for 2008: the amount of that payment remained exactly what it would have been under the Original EA Agreement.

During 2007 and 2008, four claims for violation of intellectual property rights were asserted, post-merger, by third parties against Harmonix. Those claims led to a demand by Viacom, communicated to Winshall as the Selling Shareholders' representative, for indemnification under the Merger Agreement. In the Merger Agreement, Harmonix had represented that (i) there were no outstanding intellectual property violation claims against Harmonix of which Viacom was not aware, and that (ii) no activity, business operation, or Current Game of Harmonix constituted a violation.[7] On April 24, 2008, three days before the deadline for giving notice of claims under the Merger Agreement, Viacom informed Winshall of three third-party claims that had been asserted against Viacom for violation of intellectual property rights, and advising that Viacom might seek indemnification for losses for alleged breaches of representations and warranties in the Merger Agreement.[8] On July 21, 2008, almost three months after the deadline for notifying Winshall of certain indemnity claims had elapsed, Viacom gave Winshall notice of a fourth claim— a patent infringement complaint by Konami Digital Entertainment Co. Ultimately, all four claims were disposed of, either by settlement or by court dismissal.

In September 2008, four months after the contractual escrow period had ended, Winshall, on behalf of the Selling Shareholders, demanded the release of the escrowed funds. Viacom refused to consent, citing the alleged breaches of representations and warranties in the Merger Agreement. In December 2010, Winshall filed a complaint in the Delaware Court of Chancery against Viacom and Harmonix. That complaint was amended March 28, 2011, and ultimately embodied three Counts.

Count I alleges that in renegotiating the EA Agreement, Viacom and Harmonix

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breached their implied obligation of good faith and fair dealing under the Merger Agreement, by intentionally not taking advantage of their opportunity to negotiate lower distribution fees to EA for 2008. By not using that leverage, Winshall avers, Viacom and Harmonix intentionally manipulated and reduced the amount of the 2008 earn-out payment that the Selling Shareholders would otherwise have received. Viacom and Harmonix moved to dismiss Count I under Court of Chancery Rule 12(b)(6) for failure to state a claim upon which relief could be granted. In an opinion issued on November 10, 2011, the Court of Chancery granted that motion.[9]

Thereafter, the parties litigated Counts II and III of Winshall's amended complaint. Those Counts embodied disputes arising out of Viacom's claims against the Selling Shareholders for indemnification under the Merger Agreement, and out of Viacom's refusal to release the moneys held in escrow. [10] Winshall moved for summary judgment on Counts II and III. By opinion dated December 12, 2012, the Court of Chancery granted that motion, [11] and in its final judgment, the court declared that Viacom was not entitled to indemnification and ordered the release of the escrowed funds.

Winshall appealed to this Court from that portion of the judgment dismissing Count I of the amended complaint. Viacom and Harmonix cross-appealed from those portions of the order awarding summary judgment to Winshall on Counts II and III. For the reasons that follow, we uphold the judgment in its entirety.

THE CONTENTIONS, THE ISSUES AND THE STANDARDS OF REVIEW

A. Winshall's Appeal

On his appeal, Winshall claims that the Court of Chancery reversibly erred by dismissing his complaint, because (he urges) the complaint alleges a cognizable claim for breach of the implied covenant of good faith and fair dealing. Winshall advances that position on two separate grounds. First, he contends that the amended complaint properly alleges that the Selling Shareholders had a reasonable expectation— and the Merger Agreement imposed an implied obligation— that Viacom would not manipulate Harmonix's cost structure so as to reduce the 2008 earn-out payment to the Selling Shareholders. Second, by not using its bargaining power to decrease the 2008 distribution fee to EA when negotiating the Amended EA Agreement, and instead by shifting the expense decrease into later years, Viacom acted in bad faith and breached that implied obligation. Viacom vigorously opposes these claims.

The issue presented on Winshall's appeal is whether, with all reasonable inferences drawn in favor of the plaintiff, the amended complaint alleges a reasonably conceivable set of facts under which the plaintiff would be entitled to relief. More specifically, the issue is whether the plaintiff adequately pled an implied contractual obligation that the Defendants ...


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