Delaware Supreme Court Decision Suggests Drafting Points for Indemnification Notice Provisions –Thompson v. Sonova

In Thompson Street Capital Partners v. Sonova U.S. Hearing Instruments (Apr. 28, 2025), the Delaware Supreme Court addressed a dispute over an indemnification claim notice delivered by Sonova to Thompson following Sonova’s acquisition of certain audiology practice groups from Thompson.

The Court of Chancery (Mar. 25, 2025) had held that Sonova’s notice met the timing and specificity requirements set forth in the parties’ merger agreement. The Delaware Supreme Court overturned that decision, holding that it was reasonably conceivable that the notice did not meet the requirements, and that the buyer therefore had forfeited its right to indemnification. The Supreme Court remanded the case for further fact-finding relating to whether the timing and specificity requirements were material to the agreement and, if so, whether the noncompliance would result in a “disproportionate” forfeiture.

Key Points

• The decision serves as a reminder that non-compliance with contractual requirements for an indemnification claim notice may or may not result in forfeiture of the indemnification right, depending on the agreement language and the circumstances. The Supreme Court found in this case that noncompliance could potentially lead to forfeiture of the indemnification right because the merger agreement specifically and clearly stated that the buyer would have no right to indemnification unless it provided notice of an indemnification claim pursuant to the provisions set forth in the agreement. Further, however, the court stated that noncompliance with the notice requirements would lead to forfeiture only if the notice requirements were material to the parties’ agreement and would not cause a “disproportionate” forfeiture. Those factual issues precluded judicial determination at the pleading stage and necessitated a trial, the Supreme Court held.
• Based on Thompson, merger agreement parties should consider certain drafting changes to standard indemnification notice provisions. See “Practice Points” below.

Background. The parties’ Merger Agreement and Escrow Agreement provided that Sonova could recover from an “Escrow Indemnification Fund” its damages arising from breaches by Thompson of its representations and warranties set forth in the Merger Agreement. After closing, Sonova provided notice to Thompson and the escrow agent of a claim for indemnification based on billing practices at the audiology practices that Thompson believed were not in compliance with applicable laws and reimbursement rules. Sonova sought unquantified damages exceeding the full amount of the Escrow Indemnification Fund.

Thompson brought suit in the Court of Chancery, seeking an order declaring that Sonova’s indemnification notice was deficient and therefore could not serve as a basis to withhold the escrowed funds. The Court of Chancery dismissed Thompson’s Complaint, ruling that Sonova’s indemnification notice was not deficient. Thompson appealed. The Delaware Supreme Court held that (i) the Merger Agreement’s indemnification notice provisions clearly indicated a potential for forfeiture of the indemnification right if the notice was deficient because they plainly stated that there was no right to indemnification unless the required notice was provided; but (ii) Sonova’s noncompliance with the timing and specificity requirements for the notice could be excused if they were not material to the parties’ agreement and the noncompliance would result in a “disproportionate forfeiture.” The Supreme Court remanded for fact-finding on the issues of materiality and disproportionate forfeiture.

Discussion

The Merger Agreement’s notice requirements. The Merger Agreement set forth the following requirements for an indemnification claim notice (the “Notice Requirements”): (i) Timing. The notice had to be provided reasonably promptly, but in any event not later than 30 days after Sonova became actually aware of the claim, provided that no delay in providing the notice would relieve Thompson from its indemnification obligations except to the extent the delay actually and materially prejudiced Thompson. (ii) Specificity. The notice had to describe the indemnification claim in reasonable detail; include the justification for the demand with reasonable specificity; include copies of all available material written evidence; and, if reasonably practical, indicate the estimated amount of damages. (iii) Compliance. There was no right to recover indemnification unless Thompson was notified in writing of the claim, pursuant to the indemnification provisions, on or before the Survival Date.

The Court of Chancery’s decision. Sonova argued that it had complied with the Notice Requirements, as the level of detail Thompson sought was not required and some of the information Thompson sought was unavailable. Sonova further argued that, in any event, the Merger Agreement did not permit Thompson to have a timely claim notice declared “invalid on its face” because Thompson subjectively believed the substantive content of the notice to be inadequate. The Court of Chancery, in a letter opinion, focused on the notice requirements in the parties’ Escrow Agreement, rather than the more stringent requirements set forth in the Merger Agreement. With respect to timing, the Escrow Agreement provisions set forth a specific date as a deadline for notice, and (unlike the Merger Agreement) did not require that notice be delivered within 30 days after the party became aware of the matter. Sonova had delivered its claim notice by the Escrow Agreement deadline. With respect to specificity, the Escrow Agreement provisions, while largely tracking the Merger Agreement requirements, generally called for less specificity, and (unlike the Merger Agreement) did not require that written materials substantiating the claim be provided. The Court of Chancery held that, consistent with the Escrow Agreement’s limited scope and purpose, the notice only had to make the escrow agent aware that were pending indemnification claims, which it had.

The Court of Chancery, “for thoroughness,” also addressed Thompson’s claim that the notice was not timely under the Merger Agreement. The court reasoned that, even if Sonova had had knowledge of the underlying facts for more than 30 days before providing the notice, Thompson had not pled the actual and material prejudice the Merger Agreement required to deem the notice untimely—rather, in the court’s view, Thompson’s statements about prejudice were “vague, conclusory and not supported by the facts.”

The Supreme Court rejected the Court of Chancery’s emphasis on the Escrow Agreement’s (rather than the Merger Agreement’s) notice provisions. The Supreme Court, noting that the Merger Agreement incorporated the Escrow Agreement, stated that the two agreements had to be read and interpreted as an integrated whole. Thus, Sonova had to comply with the notice requirements under both agreements, including the more stringent requirements under the Merger Agreement.

The Supreme Court held that Sonova’s noncompliance with the Notice Requirements could result in forfeiture of its indemnification right. Delaware is a contractarian state, but Delaware common law generally disfavors forfeitures—and “[t]hat tension has led Delaware courts to look to whether the language [in the parties’ agreement] clearly provides for a forfeiture,” the Supreme Court wrote. If the language does not, the court will construe the agreement to avoid causing a forfeiture. Here, the Supreme Court found that the Merger Agreement unambiguously provided for potential forfeiture: “[Sonova] shall have no right to recover any amounts pursuant to Section 9.2 unless [it] notifies [Thompson] in writing of such Claim pursuant to Section 9.3 on or before the Survival Date” (emphasis added). The Supreme Court observed that, in cases where Delaware courts have declined to find that notice requirements provided for potential forfeiture, the agreements at issue, unlike this Merger Agreement, were silent with respect to the consequences of providing a non-conforming notice.

The Supreme Court held that, based on the record below, it was reasonably conceivable that Sonova had not complied with the Notice Requirements. First, the Supreme Court stated, in particular, other than “its own assertions in the Claim Notice itself,” Sonova had not provided with the notice any materials or evidence supporting the claim, notwithstanding Sonova’s “months investigating and analyzing these matters.” (The Supreme Court noted in a footnote, but did not address, Sonova’s statements at oral argument that there were “practical reasons” for the omission of written materials, including that Sonova’s investigation still was not completed; the information was privileged and/or work product; and the information included protected patient information.) Second, the Supreme Court stated, Sonova may have been aware of the facts underlying its claim for far longer than 30 days before the notice was delivered—as indicated in various pre-closing communications between Sonova representatives and the target company’s then-executives. Also, the Supreme Court credited as reasonably conceivable Thompson’s pleading that Sonova’s disregarding the timing deadline caused the kind of material prejudice the deadline was put in place to avoid—such as (a) increasing the risk of additional damages by disregarding contractual and statutory refund/repayment periods; (b) negating the parties’ ability to negotiate with applicable third-party payors in good faith and in a timely manner where due credit would be given; and (c) potentially implicating a greater period of noncompliance in any final damages.

The Supreme Court held that additional fact-finding was required to determine whether noncompliance with the notice requirements could be excused to avoid a forfeiture of the indemnification right. The Supreme Court cited stated the Restatement (Second) of Contracts, which provides that “to the extent that the non-occurrence of a condition would cause disproportionate forfeiture, a court may excuse the non-occurrence of that condition unless its occurrence was a material part of the agreed exchange.” In determining whether a forfeiture would be disproportionate, the Restatement provides that “the extent of the forfeiture by the obligee [must be weighed] against the importance to the obligor of the risk from which he sought to be protected and the degree to which that protection will be lost if the nonoccurrence of the condition is excused to the extent required to prevent forfeiture.” The Supreme Court wrote that this rule is “a flexible one”; its application is within the court’s discretion; and, depending on the circumstances, the embedded issues of “materiality and disproportionate forfeiture could be decided as either a question of fact or law.”  Here, the Supreme Court ruled that it could not resolve the materiality and disproportionate forfeiture questions on the record established below; therefore, the case was remanded for fat-finding on those issues.

Practice Points

• A party who seeks to ensure its ability to enforce indemnification claim notice requirements (typically a priority for sellers) should consider negotiating for the parties to set forth in their agreement that:
  • noncompliance with the notice requirements will result in forfeiture of the indemnification right;
  • the notice requirements are a material part of the agreement; and
  • forfeiture of the indemnification right due to noncompliance with the notice requirements will not cause a “disproportionate forfeiture” excusing the noncompliance.

  Buyers in particular should seek to ensure that the drafting provides sufficient flexibility in the event it lacks sufficient information by the deadline for notice to include details with respect to the claim.

• Merger agreement parties should be careful to avoid technical non-compliance or foot-faults with respect to indemnification claim notice provisions. Buyers and sellers should seek to comply strictly with the timing, content, and process requirements specified in their agreement. If the agreement requires that the notice include written materials substantiating the claim, written materials should be provided with the notice even if the claimant’s investigation has not been completed. Where there may be confidentiality concerns about providing certain materials, the claimant should consider providing materials with redactions (even if substantial), rather than not providing them at all. Further, not only should indemnification notice provisions be drafted carefully, but so too should the indemnification claim notices themselves. It is generally a good practice to track in the notice the precise language of the notice requirements—for example (although not an issue in Thompson), if the agreement requires that the notice state what damages the party will incur, the party should not state in its notice that it may incur the following damages.
• Drafters should make clear the relationship between the indemnification claim notice provisions in the merger agreement and any escrow agreement. Where, as is typical, the merger agreement incorporates an escrow agreement, the agreements will be read as one unitary contractual scheme, requiring compliance with the provisions in both agreements. Drafters therefore should seek to ensure that the provisions are not inconsistent, or should make clear that certain requirements apply only for the escrow agreement notice and others apply only for the merger agreement notice. A seller should consider including an express statement that the requirements in both agreements will be applicable.
• An indemnification claimant should consider what evidence exists as to when it became aware of the underlying breach. If the merger agreement requires (as in Thompson) that the buyer provide notice within a timeframe after becoming aware of a breach, the buyer should consider whether contemporaneous emails or other communications may establish or suggest when the buyer first became aware of the breach.
• Sellers should consider seeking to have the merger agreement expressly exclude application of a transaction multiple in the calculation of indemnification losses. The issue of indemnification damages has not yet arisen in Thompson. However, we note that in another recent decision, In re Dura Medic (Ch. Ct. Feb. 20, 2025) (which also involved a private equity firm’s acquisition of a medical practice), the court held that, where the purchaser used a multiple of EBITDA to derive the purchase price, and the parties’ agreement was silent as to when a transaction multiple could be used in calculating damages for breaches of representations and warranties, a transaction multiple could be applied when calculating such damages.