Anti-Assignment Clause Merger

March 1, 2013

On February 22, 2013, in Meso Scale Diagnostics, LLC v. Roche Diagnostics GmbH, C.A. No. 5589-VCP (Del. Ch. 2013), Vice Chancellor Parsons of the Delaware Court of Chancery ruled that a provision in a license agreement prohibiting an assignment by operation of law did not apply to a reverse triangular merger.  This ruling eliminates the uncertainty Vice Chancellor Parsons created in his April 2011 motion to dismiss decision in which he indicated that there may be circumstances where a reverse triangular merger could be considered an assignment by operation of law for purposes of an anti-assignment clause.

Background

On June 22, 2010, the plaintiffs filed a complaint alleging that the acquisition by Roche Diagnostics GmbH, C.A. ("Roche") of BioVeris Corporation ("BioVeris") through a reverse triangular merger violated the anti-assignment clause found in a 2003 agreement between the plaintiffs and the predecessor entity to BioVeris, among others.  The anti-assignment clause that the plaintiffs alleged was breached stated as follows:

Neither this Agreement nor any of the rights, interests or obligations under [it] shall be assigned, in whole or in part, by operation of law or otherwise by any of the parties without the prior written consent of the other parties . . .

The Court, in its earlier Memorandum Opinion dated April 8, 2011, denying a motion to dismiss, ruled that there may be circumstances where a provision prohibiting assignment of an agreement by operation of law could be triggered by a reverse triangular merger.[1]

Analysis

In support of its summary judgment motion, Roche argued that, because the target entity in a reverse triangular merger remains intact and continues to own its own assets, BioVeris did not assign anything at the time it was acquired through a reverse triangular merger.  Roche further argued that a reverse triangular merger structure is analogous to a sale of the stock of a target corporation, and Delaware courts had repeatedly held that such a stock sale would not violate an anti-assignment provision that did not expressly prohibit a change in control. 

The plaintiffs countered that Delaware case law regarding forward triangular mergers compels the conclusion that a provision covering assignment "by operation of law" extends to all mergers, regardless of their form.[2]  The plaintiffs further argued that the Court should embrace an unreported California federal court decision, SQL Solutions Inc. v. Oracle Corporation, 1991 WL 626458 (N.D. Cal. Dec. 19, 1991), that held that an anti-assignment provision in a software license agreement that did not contain a change of ownership or control provision was triggered by a reverse triangular merger.[3]

The Court concluded that Delaware law, and specifically Section 259 of the Delaware General Corporation Law (the "DGCL"), supported Roche’s position that a reverse triangular merger generally is not an assignment by operation of law or otherwise.  Section 259 provides that:

When any merger or consolidation shall have become effective under this chapter, for all purposes of the laws of this State the separate existence of all the constituent corporations, or of all such constituent corporations except the one into which the other or others of such constituent corporations have been merged, as the case may be, shall cease and the constituent corporations shall become a new corporation, or be merged into 1 of such corporations . . . the rights, privileges, powers and franchises of each of said corporations, and all property, real, personal and mixed, and all debts due to any of said constituent corporations on whatever account . . . shall be vested in the corporation surviving or resulting from such merger or consolidation; and all property, rights, privileges, powers and franchises, and all and every other interest shall be thereafter as effectually the property of the surviving or resulting corporation as they were of the several and respective constituent corporations.  (emphasis added)

The Court pointed to cases holding that Section 259 results in only the transfer of the non-surviving corporation’s rights and obligations to the surviving corporation by operation of law.  On the other hand, the language "except the one into which the other or others of such constituent corporations have been merged" in Section 259 implies that the surviving corporation would not have effected any assignment.

As to the plaintiffs’ arguments, the Court distinguished Tenneco and Star Cellular as cases involving forward triangular mergers where the target company was not the surviving entity, whereas in this case BioVeris was the surviving entity in a reverse triangular merger.  Further, the Court declined to follow SQL Solutions because doing so would conflict with Delaware’s well-settled law that stock acquisitions, by themselves, do not result in an assignment by operation of law.

The Court also observed that its interpretation of the anti-assignment clause is consistent with the reasonable expectations of the parties, noting that the vast majority of commentary discussing reverse triangular mergers indicates that a reverse triangular merger does not constitute an assignment by operation of law. 

Conclusion

This ruling is noteworthy because it confirms the view that, until the first Meso Scale Diagnostics ruling, practitioners had long taken for granted: a reverse triangular merger does not result in an assignment by operation of law of the acquired corporation’s contracts or other assets.  The decision should provide comfort to would-be acquirors that they can structure transactions to which the DGCL is applicable in a manner that ensures that consents to assignment do not need to be obtained where there is no change of ownership or control language in the relevant anti-assignment clause.  However, the decision also serves as a reminder that, outside of the confines of the DGCL, there remains uncertainty as to the risks associated with anti-assignment clauses–it may be prudent to require that consents be obtained from applicable third parties where a license or other agreement containing such a clause is important to the target’s business.


  [1]   At this earlier motion to dismiss stage the Vice Chancellor was required to assume the truthfulness of the plaintiff’s allegation and afford the plaintiff the benefit of all reasonable inferences.  The Court declared that it could grant Roche’s motion to dismiss only if Roche’s interpretation of the anti-assignment clause was the only reasonable construction as a matter of law. Although noting that stock acquisitions do not, in and of themselves, constitute an assignment, the Court noted that the plaintiffs had alleged that the transaction in question involved more than just a change of ownership because the plaintiffs had alleged that, within months of the merger, all of BioVeris’s 200 employees were laid off, its Maryland facility was closed and its existing customers were notified that its product lines were being discontinued.  These additional circumstances, in the Court’s view, created a plausible argument "that ‘by operation of law’ was intended to cover mergers that effectively operated like an assignment, even if it might not apply to mergers merely involving changes of control."  

  [2]   SeeTenneco Automotive Inc. v. El Paso Corporation, 2002 WL 453930 (Del. Ch. 2002) and Star Cellular Telephone Company, Inc. v. Baton Rouge CGSA, Inc., 19 Del. J. Corp. L. 875 (Del. Ch. 1993) ruling that forward mergers do trigger anti-assignment provisions prohibiting assignments by operation of law.

  [3]   Since Vice Chancellor Parson’s motion to dismiss ruling in April 2011, a New Jersey federal court decision, DBA Distribution Services, Inc. v. All Source Freight Solutions, Inc., 2012 WL 845929 (D.N.J. Mar. 13, 2012), cited SQL Solutions in support of its holding that, under New Jersey law, a reverse triangular merger does constitute an assignment by operation of law.  The issue was one of first impression in New Jersey.   No other court appears to have cited with approval the SQL Solutions holding that the acquisition of a licensee under a license agreement through a reverse triangular merger results in an assignment of the license agreement. 

 

If you look at the last page or so of most commercial contracts, buried among the boilerplate clauses one will often find a provision that looks something like this:

"Neither this Agreement nor any of the rights, interests or obligations under the Agreement shall be assigned, in whole or in part, by operation of law or otherwise by either party without the prior written consent of the other party."

Lawyers refer to this as an "anti-assignment" provision, and its goal is to ensure that the two contracting parties will not be able to transfer their obligations under the agreement to someone else without first getting permission from the other party. For example, if you have contracted with an organization because of its reputation and expertise in a given area, you may not want that organization to be able to outsource that responsibility to another party.

Contract assignment issues can play a significant role in mergers and acquisitions, as buyers will want to be sure they acquire all of the seller’s key customer and vendor contracts. If these contracts require consent from the counterparties, it can add significant cost and time to a transaction. The default position under most contracts is that the contracts are assignable unless the parties have expressed an intent to the contrary. As such, anti-assignment provisions are added to contracts for just that purpose.

In one of the most common transaction structures, an asset sale, contracts have to be assigned to the acquiring party, so if contracts have anti-assignment provisions, the buyer will need to obtain the consent of the contracting parties before the contract can be transferred. If many consents are required, or if the counterparties use the opportunity to try to break contracts or otherwise extract concessions, it can add delay and uncertainty to a transaction.

To avoid this issue, acquisitions are sometimes structured as "reverse triangular mergers" where the buyer forms a subsidiary (typically called a "merger sub") which merges with and into the target company. The merger sub becomes a part of the target company, and the target company becomes a subsidiary of the buyer. In this structure, the party to the contract never changes; it is just the owners of that party that have changed. As such, transaction attorneys have long held the belief that reverse merger transactions should not be considered assignments. A recent Delaware Chancery Court case, Meso Scale Diagnostics, LLC v. Roche Diagnostics GMBH, has affirmed this position under Delaware law, which provides even further certainty on this issue.

On the flip side, when drafting contracts, if parties do want to prevent the counterparty from being able to transfer the contact in a merger, or other change of control transaction, they will need to state this very explicitly in their contracts. Anti-assignment provisions need to explicitly address merger situations and state whether the parties intend consent to be required.

It is also worth noting that the Meso Scale decision is applicable for Delaware law, and although Delaware courts are persuasive in many other states, other courts could come to a different conclusion. For example, a U.S. District Court for the Northern District of California, in SQL Solutions v. Oracle, held that a reverse triangular merger did result in an assignment by operation of law of a license agreement of the target company.

In either case, this illustrates the importance of clear drafting in contracts, and the need for experienced transaction counsel to be involved early in the deal structuring process so that issues like anti-assignment provisions can be identified early and appropriately addressed, if needed. Please call us if you have any questions or would like to discuss further.

by Bart D. Dillashaw

 

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