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Western Standard, LLC v. Sourcehov Holdings, Inc.

Court of Chancery of Delaware

July 24, 2019

WESTERN STANDARD, LLC, Individually and as Stockholder Representative for Former BancTec, Inc. Common Stockholders, Plaintiff,

          Date Submitted: April 3, 2019

          Rudolf Koch, Esquire, Matthew W. Murphy, Esquire and Anthony M. Calvano, Esquire of Richards, Layton & Finger, P.A, Wilmington, Delaware and Samuel J. Lieberman, Esquire of Sadis & Goldberg LLP, New York, New York, Attorneys for Plaintiff.

          T. Brad Davey, Esquire, Matthew F. Davis, Esquire and Kody M. Sparks, Esquire of Potter Anderson & Corroon LLP, Wilmington, Delaware, Attorneys for Defendants.



         When a Delaware court addresses a breach of contract claim at the pleadings stage, the analysis typically follows one of two paths. If the contract is unambiguous, meaning it is susceptible to only one reasonable construction, the court applies that construction to determine whether the plaintiff has stated a viable claim for breach. If the court determines the contract is ambiguous, meaning it is susceptible to two or more reasonable constructions, the court denies the motion and directs the parties to present extrinsic evidence to aid the court in its search for an objective manifestation of intent. In rare instances, however, the court is unable to divine any meaning from the contract. This is one of those cases. Because the Court cannot understand the contract, it cannot endeavor to construe it. Extrinsic evidence is required to discern what the parties were trying to accomplish and how the words they chose in their contract were meant to facilitate that intent.

         In early 2014, Defendant, Pangea Acquisitions, Inc. ("Pangea"), acquired BancTec, Inc. ("BancTec") through a merger of BancTec and a Pangea subsidiary. The merger agreement provides that contingent, or "earn-out," consideration will be paid to former BancTec stockholders in the event Pangea's controlling stockholder realizes certain returns on its post-merger Pangea stock. Plaintiff, Western Standard, LLC, the stockholder representative for BancTec stockholders as designated in the merger agreement, alleges the earn-out was triggered by a 2017 stock-for-stock transaction involving Pangea's controlling stockholder, Pangea's parent company (Defendant, SourceHOV Holdings, Inc. ("SourceHOV")) and others. Defendants disagree and refuse to pay. Hence, the breach of contract claim.

         According to Defendants, the Court need not engage in any construction of the operative contract because the stock to which the earn-out right attached was extinguished in a merger prior to the alleged triggering transaction in 2017. Alternatively, Defendants maintain that the unambiguous terms of the operative contract reveal that no earn-out payment is due. They seek dismissal of Western Standard's breach of contact claim on both grounds under Chancery Rule 12(b)(6).

         In response, Western Standard argues that the controlling stockholder's Pangea stock remained intact when the stock-for-stock transaction occurred in 2017, and Defendants' failure to pay the earn-out consideration violates the clear and unambiguous terms of the merger agreement. Alternatively, it argues the merger agreement is ambiguous and, therefore, the parties must be afforded an opportunity to present extrinsic evidence in support of their proffered constructions of the agreement.

         I have read the operative contract-many times. I have read the parties' briefs in which they offer their respective constructions of the contract-many times. But, as explained below, this is one of those rare instances where the Court cannot understand the relevant provisions of the contract at all, much less attach definitive meaning to them. Because I disagree with Defendants that the controlling stockholder's Pangea stock indisputably was extinguished prior to the alleged 2017 triggering event, I must turn to the contract and attempt to construe it, as a matter of law, before determining whether Western Standard has a viable breach of contract claim. Because I am unable to make that determination on the pleadings, the motions to dismiss must be denied.

         I. BACKGROUND

         I have drawn the facts from the allegations in the Verified Amended Complaint (the "Amended Complaint") and the exhibits attached to that pleading.[1]In resolving the motions to dismiss, I accept as true the Amended Complaint's well-pled factual allegations and draw all reasonable inferences in Plaintiff's favor.[2]

         A. The Parties and Relevant Non-Parties

         Plaintiff, Western Standard, is a limited liability company based in Los Angeles, California and was, at the time of the Pangea-BancTec merger, a BancTec common stockholder.[3] In the merger agreement between Pangea and BancTec (the "Pangea-BancTec Agreement"), Western Standard is designated as the "Stockholder Representative," an exclusive agent authorized to assert claims under the agreement on behalf of the BancTec stockholders, including claims to enforce the earn-out provision.[4]

         Defendant, Pangea, is a Delaware corporation that acquired BancTec in 2014.[5]Pangea later became a wholly owned subsidiary of SourceHOV, and is currently a subsidiary of Exela Technologies, Inc. ("Exela") following a transaction that will be described in more detail below.[6]

         Defendant, SourceHOV, is a Delaware corporation that provides information and transaction processing services.[7] It was founded by non-party, Par Chadha, who previously controlled as much as 72.8-77.5% of SourceHOV's common stock.[8]

         Non-party, HandsOnFund 4 I, LLC ("HOF4"), is an investment fund owned and controlled by Mr. Chadha.[9] Under the Pangea-BancTec Agreement, the earn-out provision is triggered if HOF4, as the controlling stockholder (designated in the Pangea-BancTec Agreement as the "Lead Investor"), realizes proceeds from a "Realization Event" "with respect to" its Pangea stock.[10]

         B. The Relevant Provisions of the Pangea-BancTec Agreement

         BancTec and Pangea executed the Pangea-BancTec Agreement on February 21, 2014, whereby BancTec merged with and into a Pangea merger subsidiary and survived as a wholly owned subsidiary of Pangea Finance, Inc. ("Pangea Finance").[11] BancTec stockholders approved the transaction on March 31, 2014, and it closed on April 3, 2014.[12]

         As consideration for the merger, BancTec common stockholders obtained the right to receive either Pangea stock or cash consideration as determined by a stated formula.[13] Regardless of their chosen form of consideration, BancTec common stockholders also received the right to $0.45 of "Per Share Contingent Consideration" if an "Earn-out Condition is satisfied."[14] Unlike a typical earn-out provision that is tied to defined performance milestones, this earn-out is tied to certain shares and certain designated events with respect to those shares. Specifically, Section 2.14(a) of the Pangea-BancTec Agreement appears to provide that the Earn-out Condition is triggered when the Lead Investor realizes a designated amount of proceeds in connection with a Realization Event:

If at any time during the period commencing on the Closing Date and ending on the seven-year anniversary thereof (the "Earn-out Period") a Realization Event shall occur resulting in the realization by the Lead Investor with respect to the shares of Parent Class A common stock held by the Lead Investor as of immediately following the Closing of proceeds (net of expenses) greater than or equal to the number of shares of Parent Class A common stock held by the Lead Investor as of immediately following the Closing, multiplied by (i) with respect to any time on or prior to the five-year anniversary of the Closing Date, $2, 000 (as adjusted for stock splits), and (ii) with respect to any time after the five-year anniversary and on or prior to the seven-year anniversary of the Closing Date, $3, 000 (as adjusted for stock splits) (the "Earn-out Condition"), then the Per Share Merger Consideration shall be increased by an amount in cash per Common Share equal to $0.45 (the "Per Share Contingent Consideration").[15]

         The definition of "Realization Event," in turn, includes three categories:

(a) a dividend or other distribution with respect to the Parent Common Stock, or (b) the sale, transfer or exchange by the Lead Investor (other than to an Affiliate) of the Parent Common Stock, or (c) the pro rata distribution by the Lead Investor of the Parent Common Stock to its equity holders . . . .[16]

         At the closing of the Pangea-BancTec merger, HOF4 (the Lead Investor) held 35, 100 Pangea shares.[17] According to Western Standard, if HOF4 or its affiliates participate in a transaction whereby they receive value equivalent to $70, 200, 000 (35, 100 shares x $2, 000) by February 21, 2019, then former BancTec stockholders must receive an additional $0.45 per share, or a total of $8, 113, 968.90 in earn-out consideration.[18]

         The Pangea-BancTec Agreement lays out a procedure for Pangea to notify Western Standard if the earn-out obligation is triggered. If "(i) the Lead Investor ceases to own any shares of Parent Common Stock, (ii) . . . a Realization Event [occurs] pursuant to which the Earn-Out Condition is satisfied, or (iii) the final day of the Earn-out Period" occurs, Pangea must deliver to Western Standard "a statement (the "Earn-out Statement") setting forth the calculation of the net proceeds received by the Lead Investor in connection with any and all Realization Events[.]"[19] "If the Contingent Consideration is, on the face of the Earn-out Statement, payable to the Stockholders," then Pangea must mail each stockholder its Per Share Contingent Consideration.[20] Following the delivery of the Earn-out Statement, Pangea must provide Western Standard:

with reasonable access to its, the Surviving Corporation's and the Lead Investor's books and records for the purposes of determining whether the Earn-out Condition has been satisfied and shall otherwise cooperate with any reasonable requests for financial information by the Stockholder Representative that is reasonably necessary for its review of the Earn-out Statement or any determination as to whether the Earn-out Condition has been satisfied.[21]

         If Western Standard disputes the Earn-out Statement, it may request a review of the statement.[22] And if Pangea and Western Standard cannot resolve their dispute after thirty days, they must seek the assistance of a mutually agreed upon "nationally recognized independent public accounting firm" who will make a binding determination.[23]

         The Pangea-BancTec Agreement does not guarantee that the earn-out consideration will be paid. Instead, as is typical in earn-out arrangements, Pangea acknowledges its intent to pursue the business of Pangea and its subsidiaries with the goal of satisfying the Earn-Out Condition, [24] while BancTec and its stockholders agree that:

(i) The Lead Investor, Parent, Merger Sub and their respective Affiliates retain the right in their sole discretion, for any reason or for no reason, not to engage in events constituting Realization Events, in which event no Per Share Contingent Consideration shall be payable, and (ii) the Lead Investor, Parent, Merger Sub and their respective Affiliates have no express or implied duty to pursue satisfaction of the Earn-out Condition or to conduct the business of the Surviving Corporation in a manner so as to cause the satisfaction of the Earn-out Condition.[25]

         C. Pangea Becomes a Wholly Owned Subsidiary of SourceHOV

         On September 26, 2014, SourceHOV and Pangea executed a merger agreement (the "SourceHOV-Pangea Agreement") whereby SourceHOV and BancTec combined to become one of the largest transaction processing solution providers in the world.[26] To facilitate the transaction, SourceHOV created a merger subsidiary ("BTG") that merged into Pangea, with Pangea surviving as a subsidiary of SourceHOV. [27]

         Under Section 1.5(b) of the SourceHOV-Pangea Agreement, "each share of the common stock . . . of [BTG] then outstanding [was] exchanged for one validly issued share of common stock of [Pangea]," and "each share of Pangea Common Stock" was converted into the right to receive 1.0967 shares of SourceHOV common stock. [28] HOF4 thus received 38, 494 shares of SourceHOV common stock through the conversion of its 35, 100 shares of Pangea common stock.[29]

         Pangea emerged from the transaction looking very much as it did before the merger. Its certificate of incorporation and bylaws remained unchanged and it continued to be controlled by the same stockholders.[30]

         D. SourceHOV Becomes a Wholly Owned Subsidiary of Exela

         In July 2017, SourceHOV merged with and survived as a subsidiary of a special purpose acquisition company called Quinpario Acquisition Corp. 2, which then changed its name to Exela.[31] Prior to executing the merger, SourceHOV equity holders converted their interests into units of a wholly owned merger subsidiary of SourceHOV called Ex-Sigma LLC ("Ex-Sigma"), with SourceHOV surviving as a wholly owned subsidiary of Ex-Sigma.[32] As a result of the SourceHOV-Exela merger, former SourceHOV equity holders (or, more precisely, Ex-Sigma unit holders) received 80, 600, 000 shares of Exela stock.[33] The merger consideration was held by a subsidiary of Ex-Sigma, Ex-Sigma 2, LLC, and pledged to secure a loan used to complete the SourceHOV-Exela merger.[34]

         On March 17, 2017, Western Standard wrote to counsel for SourceHOV to provide notice that the SourceHOV-Exela merger had triggered the earn-out provision.[35] Counsel for the Defendants replied four days later, explaining that "[a]s a result of [the SourceHOV-Pangea merger], the obligation to pay the Contingent Consideration transferred with the Banctec [sic] Stock to SourceHOV Holdings, Inc. in the event of its disposal of BancTec."[36] Counsel went on to explain that because BancTec remained a subsidiary of SourceHOV after SourceHOV's merger with Exela, a Realization Event had not occurred.[37]

         On May 15, 2017, Western Standard suggested that the contractually mandated arbitration might be necessary and requested books and records from SourceHOV and HOF4 under section 2.14(e) of the Pangea-BancTec Agreement to determine whether the earn-out provision had been triggered.[38] SourceHOV refused to comply and further stated that arbitration was inappropriate as the dispute between the parties involved the interpretation of the earn-out provision and whether it had been triggered, not the calculation of any earn-out consideration due and owing.[39]

         E. Procedural Posture

         On March 13, 2018, Western Standard filed its Verified Complaint. On April 11, 2018, HOF4 and its affiliates sold seven million Exela shares in a public offering and received $35 million in proceeds.[40] Western Standard filed its Amended Complaint on July 27, 2018, in which it alleges that the April 2018 public offering may be another Realization Event that would trigger the earn-out provision.

         The Amended Complaint alleges two counts of breach of contract: Count I concerns Defendants' refusal to pay the earn-out consideration and Count II concerns Defendants' refusal to comply with the books and records and arbitration provisions relating to the earn-out obligation. As relief, Plaintiff seeks direct damages of $8, 113, 968.90 for breach of the earn-out provision and at least $25, 000 for legal fees and expenses in pursuing books and records and the bargained-for arbitration. SourceHOV moved to dismiss the Amended Complaint on August 10, 2018, and Pangea moved to dismiss eleven days later.[41]

         II. ANALYSIS

         Under Court of Chancery Rule 12(b)(6), dismissal is appropriate only where the Court determines "with reasonable certainty that the plaintiff would not be entitled to relief under any set of facts susceptible of proof."[42] In considering a motion to dismiss, the Court accepts as true all well-pled allegations in the complaint and draws all reasonable inferences from those facts in plaintiff's favor.[43] But the Court need not "accept every strained interpretation of the allegations proposed by the plaintiff, "[44] nor must it "credit conclusory allegations that are not supported by specific facts, or draw unreasonable inferences in the plaintiff's favor."[45]

         A. The Pangea Shares Were Not Necessarily Extinguished in the Pangea-SourceHOV Merger

         According to Defendants, because the earn-out right is tied to "the shares of Parent Class A common stock held by the Lead Investor as of immediately following the Closing[, ]" there would be no need to engage in any contract construction if the Court determines that these earn-out shares no longer existed at the time of the alleged Realization Event (the SourceHOV-Exela merger). And that is precisely what happened, Defendants argue, because the Lead Investor's Pangea shares ceased to exist in 2014 when they were converted into the right to receive stock in SourceHOV in the SourceHOV-Pangea merger. This, of course, was years prior to the SourceHOV-Exela merger in 2017.

         Although it is tempting to avoid untangling the knot that is Section 2.14(a) of the Pangea-BancTec Agreement, I cannot accept Defendants' argument that the shares of a target entity (in this case Pangea) cease to exist, come what may, upon the consummation of a reverse triangular merger. In a typical two-party merger, two entities combine into one, with one entity disappearing and the other surviving.[46]The stock of the disappearing entity itself disappears by operation of law upon consummation of the transaction.[47] In a reverse triangular merger, however, the acquirer creates a subsidiary that merges into the target. The merger subsidiary (and its stock) disappear while the target (and its stock) survive as a subsidiary of the acquirer.[48] Thus, the effect of a reverse triangular merger "is the same as the purchase of . . . the outstanding stock" of the target.[49] Although stock of the target may be converted into the right to receive stock in the acquirer (or cash or a combination of both), [50] the target's stock, by virtue of the deal's structure, does not disappear because it is through the target's stock that the acquirer wholly owns the target as a subsidiary.[51] That is the case here; Pangea merged into BTG and survived, unaffected, as a subsidiary of SourceHOV.[52] Accordingly, I cannot conclude on the pleadings that the Lead Investor's Pangea shares no longer existed in 2017 simply by virtue of the structure of the SourceHOV-Exela merger.[53]

         B. The Pangea-BancTec ...

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