Winshall v. Viacom International, Inc.

55 A.3d 629, 2011 WL 5506084, 2011 Del. Ch. LEXIS 168
CourtCourt of Chancery of Delaware
DecidedNovember 10, 2011
DocketCivil Action No. 6074-CS
StatusPublished
Cited by36 cases

This text of 55 A.3d 629 (Winshall v. Viacom International, Inc.) is published on Counsel Stack Legal Research, covering Court of Chancery of Delaware primary law. Counsel Stack provides free access to over 12 million legal documents including statutes, case law, regulations, and constitutions.

Bluebook
Winshall v. Viacom International, Inc., 55 A.3d 629, 2011 WL 5506084, 2011 Del. Ch. LEXIS 168 (Del. Ct. App. 2011).

Opinion

OPINION

STRINE, Chancellor.

I. Introduction

This is a dispute over earn-out payments. In 2006, defendant Viacom International, Inc., a media conglomerate whose portfolio includes such brands as MTV and Nickelodeon, acquired defendant Harmonix Music Systems, Inc., a company best known for creating the music-oriented video games Rock Band and Guitar Hero (the “Merger”). Under a merger agreement entered into by Viacom, Harmonix and the selling stockholders of Harmonix (the “Selling Stockholders”), including the plaintiff, Walter A. Winshall, as the representative of the Selling Stockholders (the “Merger Agreement”), Viacom promised the Selling Stockholders an up-front payment of $175 million for their shares, as well as the contingent right to receive uncapped earn-out payments based on Harmonix’s financial performance in the two years following the Merger, 2007 and 2008.

About one year after the Merger closed, Harmonix released a new video game, Rock Band, which was an immediate success. Harmonix had already entered into an agreement with Electronic Arts, Inc. (“EA”) for the distribution of Rock Band through March 2010, but the game’s popularity caused EA to want to renegotiate the contract in order to gain a broader scope of rights to Rock Band and its sequels. Because of EA’s interest in amending the distribution agreement, Harmonix and Viacom allegedly had an opportunity to negotiate for an immediate reduction in distribution fees that would have potentially increased the Selling Stockholders’ earn-out payments for 2008. But, at the direction of Viacom, Harmonix did not amend its contract with EA so as to immediately reduce its distribution fees. Rath[631]*631er, Harmonix and EA’s amended agreement involved a reduction in distribution fees in upcoming years, after the expiration of the earn-out period. The revised contract granted EA a number of important new rights having nothing to do with EA’s already firm right to distribute Rock Band during 2008. These new rights included a clarification of EA’s distribution rights to Rock Band sequels, an expansion of EA’s distribution rights to cover Rock Band products made for handheld gaming devices, and an obligation on the part of Harmonix to release The Beatles: Rock Band or a comparable product during the term of the distribution agreement with EA.

Winshall sued Viacom and Harmonix on behalf of the Selling Stockholders, alleging that Viacom and Harmonix purposefully renegotiated the distribution contract with EA so as to reduce the earn-out payments payable to the Harmonix stockholders, and thus breached the covenant of good faith and fair dealing implied in the Merger Agreement. I dismiss Winshall’s claim.

Winshall would have me imply a duty on the part of Viacom and Harmonix to take any opportunity during the earn-out period to increase the earn-out payment for 2008, regardless of whether that opportunity was offered to Viacom and Harmonix in exchange for granting the counterparty rights to future assets in which the recipients of the earn-outs had no reasonable expectancy interest. Even assuming that Viacom and Harmonix intentionally forewent a 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 of the benefits for themselves, Viacom and Harmonix took no steps to reduce any reasonable contractual expectation of the Selling Stockholders. It would be inequitable for this court to imply a duty on Viacom and Harmonix’s part to share with the Selling Stockholders the benefits of a renegotiated contract addressing EA’s right to distribute Harmo-nix 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 Winshall seeks to have me do.

II. Factual Background

The following facts are drawn exclusively from Winshall’s amended complaint (the “Amended Complaint”), the exhibits attached thereto, and the documents that it incorporates.1

A. Viacom Acquires Harmonix

On September 20, 2006, after the release and success of Harmonix’s video game Guitar Hero, Viacom, Harmonix, the Selling Stockholders, and Winshall entered into the Merger Agreement.2 As a result [632]*632of the Merger, which closed on October 27, 2006, Harmonix became a wholly-owned subsidiary of Viacom. The Selling Stockholders relinquished their shares in exchange for two forms of consideration. First, they were paid $175 million in cash, due at closing. Second, they received the contingent right to be paid cash earn-outs for the years 2007 and 2008 based on the extent to which Harmonix’s “Gross Profit” exceeded certain targets.3

Under the Merger Agreement, Gross Profit is defined as the sum of “Product Gross Profit” for all of Harmonix’s products, Product Gross Profit being the difference between (i) the “Net Revenue” attributable to the product and (ii) the sum of all “Direct Variable Costs” attributable to the product.4 Direct Variable Costs consist of, among other things, “distribution fees” and “royalties payable to third parties.”5 As a result of the Merger, the Selling Stockholders became entitled to receive cash payments equal to three and a half times the excess, if any, over Gross Profit thresholds of $32 million in 2007 and $45 million in 2008. The amount of the earn-out payments was not subject to a cap or ceiling.

In other words, the Selling Stockholders were entitled under the Merger Agreement to potentially unlimited cash payments based on the cumulative financial performance of all Harmonix products in the two years following the company’s acquisition by Viacom. Notably, the Merger Agreement does not contain any provision governing the operation of Harmonix during the earn-out period, nor does it contain any efforts clause related to the earn-out payments. The Merger Agreement further provides that both Winshall (as the Selling Stockholders’ representative) and Viacom are entitled to submit any disputes relating to the amounts of the 2007 and 2008 earn-out payments to a “Resolution Accountant,” whose determination will be binding on the parties.6

B. Hamionix Enters Into A Distribution Agreement With EA

On March 6, 2007, Harmonix entered into an agreement with EA for the distribution of a new project, the video game Rock Band (the “Original EA Agreement”). Under the Original EA Agreement, which had a term of three years and was set to expire on March 6, 2010,7 Harmonix agreed to pay sales and other fees to EA for the distribution of Rock Band. Winshall alleges that these fees were “one of the largest single expenses incurred by Harmonix.”8 The Original EA Agreement provided that, if EA met a specified “sequel threshold” by earning a certain amount of revenues by the six-month anniversary of Rock Band’s launch, it would receive the right to distribute sequels to Rock Band.9 If EA did not meet the sequel threshold requirement by the time Harmonix began work on a sequel, it would receive a right of “first negotiation” to such sequel.10

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Bluebook (online)
55 A.3d 629, 2011 WL 5506084, 2011 Del. Ch. LEXIS 168, Counsel Stack Legal Research, https://law.counselstack.com/opinion/winshall-v-viacom-international-inc-delch-2011.