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Court Examines Intended Third Party Beneficiaries of Indemnification Provision

By | August 22, 2020

In CHS/Community Health Systems, Inc. et al v. Steward Health Care System LLC, the Delaware Court of Chancery examined who was an intended third-party beneficiary of an indemnification provision in an Asset Purchase Agreement.

The dispute arose in a transaction where Steward agreed to purchase substantially all the assets of certain hospitals owned by CHS.

Specifically, the APA listed a series of “Seller Entities” that would “sell to [Steward] . . . substantially all of [their] assets . . . which are . . . used in connection with . . . [a] ‘Healthcare Business.’”

Steward agreed to “assume . . . the future payment and performance of . . . all obligations accruing . . . after the Effective Time with respect to the Assumed Contracts.”

In the indemnification provision, Steward also promised to “defend, indemnify and hold harmless [CHS] and its Affiliates . . . from and against any and all Losses” incurred in connection with any of the Assumed Contracts. In turn, the APA defined a party’s “Affiliates” to include “any other Person directly or indirectly controlling or controlled by, or under direct or indirect common control with, such specified person.”

Following the Closing, an Affiliate of [CHS], CHSPSC paid approximately $3,000,000 to satisfy contractual obligations that it believed met the definition of “Assumed Liabilities” under the APA—meaning they should have been paid by Steward. CHSPC was one of the plaintiffs in a law suit to recover these costs.

Specifically, CHSPSC sought to hold Steward to its promise to “indemnify . . . CHS and its Affiliates” (i.e., CHSPSC) for Losses incurred “in connection with” the Assumed Contracts.  CHSPSC brought this claim, not as a party to the APA, but as an “intended third-party beneficiary.”

Steward argued CHSPSC lacked standing to sue for indemnification under the APA. In support of the argument, Steward cited Section 12.22 of the APA, which stated (emphasis added):

“The terms and provisions of this Agreement are intended solely for the benefit of [CHS], [Steward], their Affiliates and their respective permitted successors or assigns, and it is not the intention of the parties to confer, and this Agreement shall not confer, third-party beneficiary rights upon any other person other than the Seller Entities and the Buyer Entities, which the parties agree are express third party beneficiaries of the rights of Seller and Buyer, respectively”

CHSPSC was not a defined Seller Entity in the APA.

CHSPSC emphasized that the indemnification section extended an indemnification right to CHS “and its Affiliates.”  Along similar lines, CHSPSC underscored language in Section 12.22 that “the terms . . . of this Agreement are intended solely for the benefit of [] [CHS and its] Affiliates.” Also, CHSPSC was alleged to be a CHS Affiliate.  The Court of Chancery was satisfied that CHSPSC’s reading was reasonable.

The Court also found Steward’s interpretation of the APA was also reasonable. Steward emphasized the second clause in Section 12.22, where the parties stated, “it is not the intention of the parties to confer, and this Agreement shall not confer, third-party beneficiary rights upon any other person other than the Seller Entities. . . .” Because, as Steward argued, the Seller Entities were all “Affiliates” of CHS as that term is used in the APA, the only way to ascribe independent meaning to the second clause in Section 12.22 was to read it as limiting the universe of CHS “Affiliates” entitled to third party beneficiary status (i.e., only the “Seller Entities”). If all CHS “Affiliates” had third-party beneficiary standing, then the second clause in Section 12.22 added nothing.

The Court denied Steward’s motion to dismiss the claim.  The Court was satisfied the APA was ambiguous as to whether CHSPSC has standing to sue for indemnity as a third party beneficiary. Because the APA was ambiguous, it could not be determined on the pleadings whether “an express, enforceable contract that controls” CHSPSC’s relationship with Steward actually existed.

Contact Steve Quinlivan for more information.