Narrowstep, Inc. v. Onstream Media Corp.: Court of Chancery Relies on United States Supreme Court’s Twombly Motion to Dismiss Standard in Analyzing Failed Merger Claims Against Acquiror
February 1, 2011
In Narrowstep, Inc. v. Onstream Media Corp., C.A. No. 5114-VCP (Del. Ch. Dec. 22, 2010), the Court of Chancery, expressly relying on the motion to dismiss standard articulated by the United States Supreme Court in Bell Atlantic v. Twombly, dismissed an implied covenant of good faith and fair dealing claim but refused to dismiss claims for breach of fiduciary duty, fraud and unjust enrichment in connection with the failed merger between Narrowstep Inc. (“Narrowstep”) and Onstream Media Corporation (“Onstream”).
After engaging in a process to locate potential acquirors, Narrowstep ultimately entered into a merger agreement with Onstream, one of its competitors in the internet TV industry, in May 2008. In a decision that the Court found to be curious and perhaps unwise, as part of the merger agreement, Narrowstep agreed to cede all operational control of its business to Onstream before the closing of the merger in order to expedite the integration of the companies and to create immediate cost savings. This action, according to Narrowstep, had the immediate effect of causing it to be “completely dependent on Onstream for its continued survival.”
Shortly after obtaining operational control of Narrowstep, Onstream began expressing concerns regarding Narrowstep’s business. While Narrowstep may have disagreed with these concerns and previously disclosed information on all of the related topics to Onstream during the due diligence process, its inability to operate independently of Onstream caused it to agree to several concessions, including two reductions in the merger price. After unsuccessfully attempting to obtain a third price reduction, Onstream purported to exercise its rights under the merger agreement to terminate the proposed merger. Narrowstep filed suit asserting, inter alia, breach of the merger agreement, breach of the implied covenant of good faith and fair dealing, fraud and unjust enrichment.
In addressing Onstream’s motion to dismiss, the Court relied on the standard recently articulated by the United States Supreme Court in Bell Atlantic v. Twombly which provided that, in evaluating a motion to dismiss, “the court must determine whether the complaint offers sufficient facts to plausibly suggest that the plaintiff will ultimately be entitled to the relief she seeks.” This standard replaced the more lenient, pre-Twombly standard in which dismissal was only appropriate if a court determined with reasonable certainty that the plaintiff cannot prevail on any set of facts that can be inferred from the complaint. In applying the Twombly standard to Narrowstep’s complaint, the Court found that it alleged sufficient facts to plausibly suggest that Narrowstep will ultimately be entitled to relief for its breach of the merger agreement, fraud and unjust enrichment claims, but did not allege sufficient facts for its implied covenant of good faith and fair dealing claim.
With regard to Narrowstep’s breach of contract claims, the Court found that Narrowstep alleged sufficient facts to plausibly suggest that Onstream failed to take all steps necessary to meet its obligations under the merger agreement and instead deliberately and in bad faith took actions to prevent the timely filing of a registration statement and intentionally manufactured concerns regarding topics that were addressed during due diligence in order to delay the closing of the merger. Similarly, in addressing Narrowstep’s common law and equitable fraud claims, the Court focused on Narrowstep’s allegations that Onstream made several false representations regarding its desire to close the merger expeditiously while engaging in a scheme to make Narrowstep dependent on it in order to obtain a reduced merger price or strip Narrowstep, a competitor, of its value. Narrowstep’s dependence on Onstream forced it to agree to several concessions and price reductions and rely only on Onstream’s continuous reassurances that the merger would eventually close.
The Court did, however, grant Onstream’s motion to dismiss with regard to Narrowstep’s implied covenant of good faith and fair dealing claim. Narrowstep alleged that Onstream violated the implied covenant by not using its reasonable best efforts to close the merger expeditiously and by repeatedly delaying the closing of the merger in bad faith. In addressing the implied covenant claims, the Court noted that, due to its narrow purpose, the implied covenant is “rarely invoked successfully” and explained that the implied covenant “operates only in that narrow band of cases where the contract as a whole speaks sufficiently to suggest an obligation and point to a result, but does not speak directly enough to provide an explicit answer.” Narrowstep’s claims, by contrast, were general accusations of bad faith that were duplicative of its breach of contract claims and either did not identify a specific implied contractual obligation that was breached or sought to override an explicit provision of the merger agreement.