Good Faith, Fair Dealing, and the Stones v. The Beatles

The Delaware Court of Chancery Ranks the Beatles Versus the Rolling Stones (and Also Talks About the Obligation of Good Faith and Fair Dealing)

      Last Thursday (Nov. 10, 2011), the Delaware Court of Chancery (Chancellor Strine) issued the opinion in Winshall v. Viacom International, Inc., 2011 WL 5506084.  It is quite possible this opinion will be most remembered for the conclusion of Chancellor Strine that the Beatles were a better group than were the Rolling Stones.  See id. at footnote 44 and accompanying text.  Still, this decision is a furthering interesting stage in the definition of the parameters of the obligation of good faith and fair dealing.

      The Plaintiffs had sold Harmonix Music Systems, Inc. to Viacom by means of a merger agreement including a contingent right to receive certain payments based upon Harmonix’s financial performance in the two years following the merger.  Harmonix was itself a developer of video games.  A year after the closure on the merger and during the earn-out period, Harmonix released the “Rock Band” game.  In light of the success of Rock Band, Electronic Arts (“EA”) sought to renegotiate its distribution agreement with Harmonix for the purpose of acquiring greater distribution rights to both Rock Band and any sequels that might be issued.  As renegotiated, in return for the right to distribute certain Rock Band sequels and as well the right to expand its distribution channels to include hand-held devices, distribution fees being paid by Harmonix were reduced for future years, all after the expiration of the earn-out for Harmonix’s original shareholders.  Had the reduced distribution fees applied during the earn-out period, the payments to the former Harmonix shareholders under the earn-out would have been increased.  Those shareholders sued Viacom alleging that the amendment distribution agreement was “purposefully renegotiated to reduce the earn-out payments, thereby breaching the covenant of good faith and fair dealing.”  In effect, Harmonix’s former shareholders asserted that the obligation of good faith and fair dealing should be applied to capture for them the benefit of any renegotiated distribution agreement.  This assertion was squarely rejected by Chancellor Strine, he writing:

Even assuming that Viacom and Harmonix intentionally forewent possible opportunity to increase Harmonix’s profits during the earn-out period and structured the amended contract with EA so that Viacom and Harmonix could enjoy all the benefits for themselves, Viacom and Harmonix took no steps to reduce any reasonable contractual expectation of the Selling Shareholders.  It would be inequitable for this Court to imply a duty on Viacom and Harmonix’s part to share with the Selling Shareholders the benefits of a renegotiated contract addressing EA’s right to distribute Harmonix products after the expiration of the earn-out period.  The implied covenant of good faith and fair dealing is not a license for a court to make stuff up, which is what [the Plaintiffs] seeks to have me do.

     The Court reiterated the rule that the implied obligation of good faith and fair dealing is not a mechanism by which, after the fact, parties to an agreement may secure for themselves benefits that they failed to negotiate.  Focusing upon the situation as it existed at the time the merger agreement was entered into, that preceding the resounding success of the Rock Band game and the consequent shift in bargaining position to Viacom with respect to the renegotiation of the distribution agreement:

I find that Winshall has failed to allege facts that support a reasonable inference that the Selling Stockholders did not get the benefit of their bargain under the Merger Agreement.  On these facts, even viewed in the light most favorable to Winshall, the Selling Shareholders could not conceivably have a reasonable expectation that Viacom and Harmonix had a duty to renegotiate the [original distribution agreement] to increase the amount of earn-out payments the Selling Stockholders would receive.

     Contrasting these facts with the situation in which the acquirer manipulates the finances of the acquired company in order to reduce the amount of the earn-out, the Chancery Court was not willing to impose a reciprocal obligation that the benefits of any future events must be allocated in such a manner as to increase the earn-out amount.