Will Delaware enforce this stipulated-damages figure, or strike it as a penalty?
Delaware applies a two-prong test: where the damages are uncertain and the amount agreed upon is reasonable, the agreement will not be disturbed. The first prong asks whether the damages that would result from a breach are uncertain or incapable of accurate calculation. The second asks whether the amount fixed is reasonable, and two factors are relevant to that: the anticipated loss by either party should the deal not close, and the difficulty of calculating that loss: the greater the difficulty, the easier it is to show the amount was reasonable. To FAIL the second prong the amount must be unconscionable or not rationally related to any measure of damages a party might conceivably sustain. Size is therefore judged proportionally rather than in absolute dollars: Brazen upheld a $550 million fee that represented 2% of a $28 billion market capitalisation, a percentage well within the range of termination fees Delaware had upheld. For sales of goods the UCC states the same idea with an express penalty rule: damages may be liquidated only at an amount reasonable in light of the anticipated or actual harm, the difficulties of proof of loss and the inconvenience or nonfeasibility of otherwise obtaining an adequate remedy, and a term fixing unreasonably large liquidated damages is void as a penalty.
The trap
In Delaware the parties' own label pulls the clause INTO the liquidated-damages test. Brazen analysed a $550 million merger termination fee as liquidated damages (rather than under the business judgment rule the Court of Chancery had used), because, as the Court put it, 'The express language in section 9.2(e) of the agreement unambiguously states that the termination fee provisions “constitute liquidated damages and not a penalty.”' Be careful with the trigger point: the Court of Chancery had reasoned that liquidated-damages analysis was inapt because the event triggering the fee was a termination and not a breach, and the Supreme Court did NOT adopt that premise: it answered that 'While a breach of the merger agreement is not the only event that would trigger payment of the termination fee', section 9.2(c) made a breach of section 7.2, coupled with other events, one of the triggers, and then found 'no compelling justification for treating the termination fee in this agreement as anything but a liquidated damages provision, in light of the express intent of the parties to have it so treated.' The fee was UPHELD: the Court held the $550 million was 'a reasonable forecast of damages' and 'neither coercive nor unconscionable'. In a footnote it added that 'the drafters of corporate documents bear the responsibility for the selection of appropriate and clear language', answering an argument that the words were boilerplate. The mirror image is Cantor Fitzgerald (2024), which cited Brazen for the point that liquidated damages 'by definition, are damages paid in the event of a breach' . That citation is a parenthetical about what liquidated damages are; the inference a drafter wants from it (that a forfeiture structured as a condition rather than as a payment for breach sits outside this test) rests on Cantor's holding instead, and Cantor stated that holding with limits, which the Delaware non-competition rule sets out.
7 authorities
The words that state the rule
In Lee Builders v. Wells, a case involving a liquidated damages provision equal to 5% of the purchase price in a contract for the sale of land, the Court of Chancery articulated the following two-prong test for analyzing the validity of the amount of liquidated damages: “Where the damages are uncertain and the amount agreed upon is reasonable, such an agreement will not be disturbed.” 12 Plaintiff argues that the termination fee, if properly analyzed as liquidated damages, fails the Lee Builders test because both portions of the fee are punitive rather than compensatory, having nothing to do with actual damages but instead being designed to punish Bell Atlantic stockholders and the subsequent third-party acquirer if Bell Atlantic were ultimately to agree to merge with another entity. We find, however, that the termination fee safely passes both prongs of the Lee Builders test. To be a valid liquidated damages provision under the first prong of the test, the damages that would result from a breach of the merger agreement must be uncertain or incapable of accurate calculation. Plaintiff does not attack the fee on this ground. Given the volatility and uncertainty in the telecommunications industry due to enactment of the Telecommunications Act of 1996 and the fast pace of technological change, one is led ineluctably to the conclusion that advance calculation of actual damages in this ease approaches near impossibility. • Plaintiff contends, however, that the $550 million fee violates the second prong of the Lee Builders test, i.e., that it is not a reasonable forecast of actual damáges, but rather a penalty intended to punish the stockholders of Bell Atlantic for not approving the merger. Plaintiffs attack is without force. Two factors are relevant to a determination of whether the amount fixed as liquidated damages is reasonable. The first factor is the anticipated loss by either party should the merger not occur. The second factor is the difficulty of calculating that loss: the greater the difficulty, the easier it is to show that the amount fixed was reasonable. 13 In fact, where the level of uncertainty surrounding a given transaction is high, “|e]xpe-rience has shown that ... the award of a court or jury is no more likely to be exact compensation than is the advance estimate of the parties themselves.” 14 Thus, to fail the second prong of Lee Builders, the amount at issue must be unconscionable 15 or not rationally related to any measure of damages a party might conceivably sustain. 16 Here, in the face of significant uncertainty, Bell Atlantic and NYNEX negotiated a fee amount and a fee structure that take into account the following: (a) the lost opportunity costs associated with a contract to deal exclusively with each other; (b) the expenses incurred during the course of nego- *49 Rating the transaction; (e) the likelihood of a higher bid emerging for the acquisition of either party; and (d) the size of termination fees in other merger transactions. The parties then settled on the $550 million fee as reasonable given these factors. Moreover, the $550 million fee represents 2% of Bell Atlantic’s market capitalization of $28 billion. This percentage falls well within the range of termination fees upheld as reasonable by the courts of this State. 17 We hold that it is within a range of reasonableness and is not a penalty.
The words that state the rule
While a breach of the merger agreement is not the only event that would trigger payment of the termination fee, the express language of section 9.2(c) states that a party’s breach of section 7.2 (which provides that the parties are required to take all action necessary to convene a stockholders’ meeting and use all commercially reasonable efforts to secure proxies to be voted in favor of the merger), coupled with other events, may trig *48 ger a party’s obligation to pay the termination fee. Thus, we find no compelling justification for treating the termination fee in this agreement as anything but a liquidated damages provision, in light of the express intent of the parties to have it so treated.
- statute6 Del. C. § 2-718enactment date not established
The words that state the rule
(1) Damages for breach by either party may be liquidated in the agreement but only at an amount which is reasonable in the light of the anticipated or actual harm caused by the breach, the difficulties of proof of loss, and the inconvenience or nonfeasibility of otherwise obtaining an adequate remedy. A term fixing unreasonably large liquidated damages is void as a penalty.
The words that state the rule
So be it, but in our view, the drafters of corporate documents bear the responsibility for the selection of appropriate and clear language.
The words that state the rule
See Brazen v. Bell Atlantic Corp., 695 A.2d 43, 67 (Del. 1997) (“[l]iquidated damages, by definition, are damages paid in the event of a breach.”)
The words that state the rule
Conclusion Because we find that actual damages in this case do not lend themselves to reasonably exact calculation, and because we further find that the $550 million termination fee was a reasonable forecast of damages and that the fee was neither coercive nor unconscionable, we hold that the fee is a valid liquidated damages provision in this merger agreement. In light of the foregoing, we affirm, albeit on somewhat different grounds, the judgment of the Court of Chancery.
The words that state the rule
The express language in section 9.2(e) of the agreement unambiguously states that the termination fee provisions “constitute liquidated damages and not a penalty.” 9 The Court of Chancery correctly found that liquidated damages, by definition, are damages paid in the event of a breach of a contract.
“Defective” means that reading found something to correct. What you are reading is the rule as it stands after that reading.