No Participation Trophy: Court of Chancery Shifts Fees For Failure To Allow Indemnifying Seller to Participate In Defense

Chancellor McCormick, of the Delaware Court of Chancery, recently was presented with the following question: If an indemnification provision in a purchase agreement clearly requires that the indemnifying party be permitted to participate in the defense of third party claims, is it a breach not to allow that participation?  It turns out that, despite a bit of creative contractual interpretation, the answer is “yes.”

The dispute in LPAS Representative, LLC v. ATH Holding Company, LLC, relates to a purchase agreement by which a predecessor of what was then known as Anthem, Inc. (“Anthem”) – a health insurance provider – acquired two entities that operated integrated health plans and pharmacies.  The agreement required the entities’ sellers to indemnify Anthem with respect to breaches of various reps and warranties, including with respect to compliance with certain healthcare laws.  The relevant indemnification provision further provided that the indemnifying party would have the right to participate in the defense of certain types of third-party claims by regulatory bodies.

Following the acquisition, Anthem became the subject of precisely those types of third-party claims, including investigations by the Department of Justice and the Center for Medicare and Medicaid Services (“CMS”).  Anthem noticed indemnification claims relating to these investigations, but it did not contact the sellers to allow them to participate in the defense of the investigations, which included responding to numerous subpoenas and entering into certain tolling agreements.

Anthem raised several defenses, first disputing whether the CMS investigation qualified as a “claim” in the first instance, given that CMS did not provide any formal notice to Anthem that it was bringing a claim.  The Court of Chancery found that no such notice was required under the definition of a Third-Party Claim.  The Court of Chancery further found that the fact that Anthem entered into a tolling agreement with CMS suggested that, in fact, there was a matter that may give rise to a claim, which is all that the agreement required.

After finding that Anthem breached its obligation to provide the sellers with participation rights, the Court of Chancery analyzed whether the sellers had waived such a breach by repudiating the purchase agreement.  Specifically, the Court of Chancery considered whether the fact that the sellers disputed their indemnification obligation in the first instance excused Anthem from allowing the sellers to participate in the defense of such would-be indemnified claims.  The Court of Chancery found that the sellers did not repudiate the agreement, but rather merely sought to vindicate their contractual rights to participate in the defense of such claims before being required to provide indemnification.

While the Court of Chancery did not address the ultimate question of whether the sellers were required to indemnify Anthem notwithstanding the participation rights breach – that will presumably be addressed in a later decision – the Court of Chancery found that the sellers were entitled to fee shifting based on the breach.  In this case, the contract meant what it said.

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