Parties to a merger or acquisition transaction must frequently wrestle with the presence of anti-assignment provisions in the target company’s existing contracts. Depending on the specific language of the anti-assignment provisions and the manner in which the transaction is structured, these provisions may require the target company to obtain the consent of the other contract parties to the assignment (transfer) of the target company's contracts to the acquiror in connection with the M&A transaction. Being forced to obtain these third party consents may delay the closing of the merger or acquisition transaction or, in rare instances, prevent it altogether.
Traditionally, certain types of transaction structures for M&A transactions have not triggered anti-assignment provisions. These included so-called stock sale transactions and reverse triangular mergers (RTM). While the choice of transaction structure in a particular transaction can be influenced by many factors, the desire to avoid obtaining third party consents has sometimes encouraged the parties to structure the transaction as either a stock sale or as an RTM.
However, the Delaware Court of Chancery’s decision in Meso Scale Diagnostics, LLC v. Roche Diagnostics GmbH, C.A. No. 5589-VCP (Del. Ch. Apr. 8, 2011), should cause M&A professionals using reverse triangular mergers as a deal structure to pause and reconsider. Meso Scale Diagnostics was a case of first impression in Delaware on the issue of whether an RTM constitutes an assignment “by operation of law.” While the Court of Chancery did not rule on the merits of the case, the court’s denial of the defendant’s motion to dismiss the case left the conventional notion that an RTM does not constitute an assignment by operation of law in unsettled waters. In light of this uncertainty, parties contemplating an RTM or other type of M&A transaction will wish to consider these issues in structuring and planning the transaction.
Background The most relevant details of the very convoluted set of facts leading to the Meso Scale litigation are as follows. In 2007, Roche Holding Ltd. (Roche) acquired BioVeris Corporation (BioVeris) in an RTM. At the time of the RTM, Roche and BioVeris were parties to a Global Consent and Agreement (Global Consent) with the plaintiffs that contained an anti-assignment clause prohibiting the assignment of certain intellectual property rights “by operation of law or otherwise” without the consent of the plaintiffs. No change in control provisions were contained in the Global Consent. The plaintiffs filed suit in 2010, alleging that, inter alia, Roche and BioVeris breached the Global Consent since (1) the RTM constituted an assignment by operation of law and (2) because if item (1), the plaintiffs’ consent was required. Thus, the defendants necessarily required the plaintiffs’ consent in order to consummate the RTM without breaching the Global Consent.
In an RTM, the acquiring party causes a wholly owned subsidiary to merge with the target, with the target being the surviving entity. The subsidiary’s shares, which the acquiring party owns, are converted into shares of the target and the outstanding shares of the target are converted into the shares of the acquiring party as consideration for the target’s shareholders (unless cash or other alternative consideration is used). Thus, the target continues as an ongoing entity -- which is the rationale for the conventional view that no assignment has occurred -- because the target still owns the same contractual rights it had prior to the merger. This end result of continuation of the entity post-RTM is similar to what occurs after a change of control caused by a stock sale.
Conversely, some M&A transactions are structured as forward triangular mergers (FTMs), where the acquiring entity causes the target to merge into its wholly owned subsidiary (and thus the acquiring entity’s subsidiary is the continuing entity). Because the target entity ceases to exist and all contracts are then owned by the acquiror’s subsidiary, FTMs are generally deemed to trigger anti-assignment by operation of law provisions in contracts.
Arguments regarding the applicability of the anti-assignment provision to an RTM In response to plaintiffs’ suit, Roche filed a motion to dismiss asserting that it was unnecessary to obtain the plaintiffs’ consent in an RTM with BioVeris because no property was assigned as a result of the merger. The only aspect that changed, Roche argued, was the ownership of a continuing corporation (BioVeris). Roche argued that such a change is not an assignment by operation of law or otherwise, it is a mere change of ownership -- so long as corporate form and contractual responsibilities are preserved. Roche likened the legal change that occurs after completion of an RTM to a stock acquisition. It cited prior decisions of the Delaware Chancery Court holding that “[w]here an acquirer purchases the stock of a corporation, that purchase does not, in and of itself, constitute an ‘assignment’ to the acquirer of any contractual rights or obligations of the corporation whose stock is sold. ”Further, Roche cited one of the same prior decisions for the proposition that “a purchase or change of ownership of such securities . . . is not regarded as assigning or delegating the contractual rights or duties of the corporation whose securities are purchased.”
The plaintiffs countered that such a change in ownership was not analogous to a purchase of shares. It supported this assertion by stating that shortly after the transaction, “Roche laid off all of BioVeris’s 200 employees, vacated BioVeris’s Maryland facility and notified BiorVeris’s existing customers that its product lines were being discontinued.” Thus, there was more than a mere change of ownership. In addition, the plaintiffs argued that an assignment “by operation of law” includes mergers. To advance this argument, the plaintiffs relied upon two lines of support. First, the plaintiffs cited prior Delaware decisions suggesting that, in the context of FTMs, mergers constitute an assignment by operation of law. Second, the plaintiffs cited a California federal court decision which held that an RTM results in an assignment by operation of law.
The Court of Chancery distinguished both Roche’s and the plaintiff’s assertions. First, distinguishing Roche’s arguments, the court noted that while RTMs have certain similar characteristics as stock acquisitions, the transaction structure is at issue in this case. Hence, stock acquisition precedent is not controlling. Conversely, the court noted, such cases do “exemplify a situation in which a mere change of ownership, without more, does not constitute an assignment as a matter of law.” Second, the court reasoned that the Delaware FTM precedent cited by the plaintiffs did not address whether an RTM would trigger an anti-assignment by operation of law provision. Finally, the court was not convinced by the plaintiffs’ California case, reasoning that (a) it is not binding precedent in Delaware, (b) it is an unpublished opinion, and thus not binding precedent even in its own jurisdiction and (c) the court’s reasoning was questionable.
Analysis The Court of Chancery appeared to be swayed by the plaintiffs’ arguments that post-merger actions taken by the acquiror in denying the motion to dismiss may have triggered anti-assignment provisions. At the very least, the court indicated that a question of law may exist.
It appears reasonable to infer from the court’s opinion that if it were to rule on the merits of this case, its decision might be as follows:
Where a transaction takes the form of an RTM, without more, to effect a change of control, anti-assignment (or, at least, anti-assignment by operation of law) provisions are not triggered. Where an RTM occurs and substantial changes occur as a result of the change of ownership (e.g., all employees are laid off, facilities are shut down and the company winds up its ongoing business with customers), anti-assignment (or, at least, anti-assignment by operation of law) provisions maybe triggered. For RTMs in between these two extremes, there is a vast gray area that the court did not even impliedly address.
The court’s ruling in Meso Scale Diagnostics is troubling in several respects. First, the court’s ruling implies that post-merger conduct may be relevant to determining whether an assignment by operation of law has occurred at the time of the closing of the merger transaction (which, by definition, will occur before the acquiror’s post-closing conduct can be known). This makes it difficult, if not impossible, for the parties to know with certainty in advance whether their particular RTM will be considered an assignment by operation of law. The court’s opinion did not discuss the apparent illogic of determining whether an assignment by operation of law has occurred at the time of the merger based upon events which will happen after the closing of the merger.
Second, the court’s ruling provides no meaningful guidance as to how an acquirer’s post-transaction actions might be evaluated or as to what actions might be enough to warrant treating the merger as an assignment by operation of law. This makes transaction planning difficult and may delay or prevent transactions from happening because either or both parties insist on making the closing subject to the receipt of third party consents that cannot be readily obtained.
Third, the court’s ruling leaves open the possibility that the same rationale might be applied to transactions with different structures, depending on the post-transaction decisions of the acquiror. For example, could the ruling also be extended to apply to a stock sale transaction? (The court’s opinion distinguished stock sale transactions, but (as noted above) the practical effect of stock sale and an RTM are virtually identical.) What about an RTM where a new parent company of the acquired entity becomes the party into which the acquiror’s subsidiary is merged?
Based on the specific facts and circumstances of a given transaction, the uncertainty created by the Meso Scale Diagnostics ruling may impact certain aspects of the transaction, such as the choice of transaction structure and choice of governing law for the transaction documents. More broadly, the ruling may also impact a company’s choice of law provisions in important commercial contracts and/or its willingness to include anti-assignment by operation of law provisions in its important commercial contracts.
Conclusion While the court has still not made a definitive ruling on the merits of this case, this decision creates some additional uncertainty and highlights some of the many considerations to address when contemplating an M&A transaction. The greatest impact of this case, if and when the court makes a decision on its merits, could be that the certain efficiencies realized under RTMs will cease to exist. Such a holding would be most significant for buyers in the due diligence stage of a transaction in their determination of which consents must be obtained in order to close the deal.
In order to avoid or diminish certain assignment risks and costs associated with RTMs, a buyer should retain experienced counsel to consider these and other risks. While an RTM may be an ideal structure for certain M&A transactions, other M&A transaction structures exist that may alleviate the risks highlighted by this case and achieve the parties’ desired goals.
If you have questions regarding this decision, please contact:
Anthony D. Konkoly216.348.5746
Our attorneys are highly skilled in the art of the deal. In fact, our experienced attorneys have executed hundreds of acquisitions and divestitures. We have honed our skills in every stage of the process-- crafting the transaction, conducting due diligence, securing financing, negotiating terms, and documenting the result. We handle transactions involving privately-held companies, private equity firms and divisions of public companies. Our transaction team is supported by legal experts in other specialties, such as tax, labor and employment, employee benefits, environmental law, real estate, and intellectual property.
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