In structuring a business acquisition, there are four commonly used transaction structures: (i) sale and purchase of all of the stock of the target company (Stock Acquisition); (ii) sale and purchase of all or substantially all of the assets of the target company (Asset Sale); (iii) merger of the target company into a subsidiary of the purchaser (Forward Triangular Merger); or (iv) merger of a subsidiary of the purchaser into the target company (Reverse Triangular Merger).
The transaction structure affects, among other things, whether consent may be required from third parties who have contractual relationships with the target company. Numerous types of contracts commonly include provisions prohibiting assignment thereof without the other party's consent. In the absence of an express non-assignment provision, federal principles governing patents and copyrights prohibit assignment of non-exclusive license agreements absent consent, as it has long been held that contracts granting non-exclusive patent or copyright licenses are personal to the patent or copyright owner.
It is widely held that a Stock Acquisition does not result in an assignment of a contract given that such transaction results in continuation of the corporate owner with only a change in stock ownership, while both an Asset Sale and a Forward Triangular Merger are widely held to result in assignment of a contract because there is a new owner of the business and its assets. Reverse Triangular Mergers have commonly been favored by deal counsel because, among other reasons, the target company continues to exist under new ownership and presumably there is no assignment of any of its contracts.
To date, only two known courts have addressed the issue of whether a Reverse Triangular Merger may result in an assignment. The first case was decided by the Northern District of California in an unpublished decision in 1991.1 That decision held that a Reverse Triangular Merger did constitute an assignment under California's merger statute, and that the resulting assignment of a software license contract without the licensor's consent was a breach that permitted the licensor to terminate the contract. To date, such decision has carried little weight given that it is not binding on California courts, and has been criticized by commentators because it was contrary to the general view that Reverse Triangular Mergers do not constitute an assignment of the target company's assets because the target continues to survive post-transaction and retains its assets. However, the Northern District of California's view is garnering more attention after the recent decision of the Delaware Court of Chancery holding that a Reverse Triangular Merger may, in certain circumstances, constitute an assignment.
In a case of first impression under Delaware law,2 the Delaware Court of Chancery held in Meso Scale Diagnostics, LLC, et al. v. Roche Diagnostics GmbH, et al., 2011 WL 1348438, *10, 13 (Del. Ch. April 8, 2011) that a Reverse Triangular Merger may constitute an assignment by "operation of law," and as such, could violate an anti-assignment provision.3 The court indicated that Stock Acquisition cases holding that a mere sale of stock does not result in an assignment are not controlling because a Reverse Triangular Merger differs in structure, but stated that such cases are relevant as they indicate that a mere change of ownership, without more, does not constitute an assignment as a matter of law.4 Likewise, the court dismissed the applicability of Forward Triangular Merger cases because such transactions also differ in structure from a Reverse Triangular Merger.5
The issue before the Delaware Court of Chancery arose at the motion to dismiss stage and considered whether plaintiffs' breach of contract claim based on the defendants' purported assignment of certain contract rights in violation of an a non-assignment provision as a result of a Reverse Triangular Merger should be dismissed because, as a matter of law, a Reverse Triangular Merger cannot result in an assignment. In determining the meaning of the non-assignment provision, the court looked at the result of the Reverse Triangular Merger that triggered the alleged assignment and was influenced by the fact that while the target company continued to exist, the merger resulted in more than a mere change of control because the target "was essentially gutted and converted into a shell company for [defendant's] benefit."6 The court determined that a reasonable interpretation of the anti-assignment provision was that the Reverse Triangular Merger did result in an assignment of the contract "by operation of law."7 Thus, the provision was ambiguous and a question of fact existed as to the parties' intended meaning of the non-assignment clause, which could not be resolved at the motion to dismiss stage. As a result, the court denied the defendants' motion to dismiss plaintiffs' breach of contract claim based on unauthorized assignment.
While a final decision in the Meso Scale Diagnostics case may shed further light on Delaware law, deal counsel and companies alike should be aware that a Reverse Triangular Merger may result in an assignment (or at least the risk that third parties could take the position that a Reverse Triangular Merger results in an assignment). In determining the potential risks involving a Reverse Triangular Merger, consideration should be given to how the target company will be operated post-closing to determine if the Reverse Triangular Merger may be viewed as more than a mere change of control. Even if there is no intent for the transaction to result in more than a mere change of control, there remains a risk that, as was determined by the Northern District of California, a Reverse Triangular Merger could be deemed an assignment.
In a situation where key contracts of the target company require consent upon an assignment, a substantial number of consents would be required upon an assignment or, if one or more third parties may not easily provide consents upon an assignment, then consideration could be given to structuring the acquisition as a Stock Sale to minimize the corresponding resources required to obtain the consents and/or the risks of failing to obtain such consents. Alternatively, consideration could be given to undertaking appropriate actions to manage the consent process and obtain timely consents and develop contingency plans should certain consents not be obtained before closing. Likewise, in conducting due diligence involving a Reverse Triangular Merger, persons will need to be mindful to carefully review agreements to identify whether they include non-assignment provisions, and even if they do not include a non-assignment provision, to identify whether they could be viewed as non-assignable under federal patent and copyright principles.