A recent ruling by the Delaware Chancery Court holds that the reverse triangular merger structure avoids the consent requirements of non-assignment clauses in target contracts.
For licensors of intellectual property and technology, as well as for all companies who are party to commercial contracts, the ruling highlights the importance of including change of control provisions in addition to non-assignment provisions in contracts in order to maintain some control over who the licensee or other party to the contract will be throughout the term of the contract. It also highlights the importance of choice of law and choice of forum provisions in commercial contracts and licenses.
In Meso Scale Diagnostics LLC v. Roche Diagnostics GmbH, the Delaware Chancery Court found that a reverse triangular merger (wherein the target company survived the merger) did not constitute an assignment, by operation of law or otherwise, of the assets of the target party to the merger.1 As a result, the consent requirement of a non-assignment clause in a target agreement (which expressly prohibited assignments, including by operation of law) was not triggered by the reverse triangular merger.
The Meso Scale ruling reinforces the importance of the following considerations to M&A practitioners and the drafters of commercial contracts and licenses:
- Deal Structure: Under Delaware law, the reverse triangular merger structure effectively avoids the restrictions of non-assignment clauses in target contracts. The Meso Scale ruling provides certainty to M&A practitioners, as it eliminates the costs of seeking counterparty consent (which can cause delays and lend leverage to counterparties) and the risk to the buyer that contracts will be invalid post-closing due to non-compliance with consent requirements.
- Change of Control Provisions: The restrictions imposed by non-assignment provisions are triggered only in certain types of acquisition transaction structures. Drafters of commercial contracts and licenses who wish to control what happens to their contracts in connection with an acquisition of the other party regardless of deal structure should negotiate for both non-assignment and change of control provisions. The two provisions are triggered by different deal structures and should be used together to prevent contracts from being assumed by competitors.
- Choice of Law and Choice of Forum: The choice of law provision, which is often overlooked, could have significant consequences. The Meso Scale finding controls when Delaware law applies, at least when the action is brought in Delaware. Under California law, however, consent requirements of non-assignment clauses most likely are triggered by reverse triangular mergers. To ensure that the chosen state’s law will apply, it also will be helpful to select that state’s courts as the forum in which an action can be brought.
Reverse Triangular Mergers
A reverse triangular merger is a form of merger in which the buyer forms a subsidiary (typically called a “merger sub”) which merges with and into the target company. The target company succeeds to the merger sub’s assets, rights and liabilities (though typically the merger sub is an empty shell without any commercial agreements or licenses). The merger sub then ceases to exist as a separate entity and the target company survives the merger as the buyer’s subsidiary.
In a forward triangular merger, the target company ceases to exist as a separate entity and the merger sub survives the merger. Note that a forward triangular merger might not avoid the consent requirement of a non-assignment clause and that such analysis will depend on the specific language of the non-assignment clause in question and the governing state law.
The relevant section of the non-assignment provision at issue in Meso Scale reads as follows:
"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 any of the parties without the prior written consent of the other parties…"
The Court found that the reverse triangular merger at issue did not trigger this provision. The Court explained that no assignment of the target company’s contracts or assets occurred in the reverse triangular merger because such contracts and other assets continued to be held by the target after the merger, as the target survived the merger as the buyer’s subsidiary. The Court referenced Section 259(a) of the Delaware General Corporate Law, which states that upon effectiveness of a merger, the separate corporate existence of all constituent corporations except the surviving corporation shall cease. Based on the statute and precedent, the court suggested that a forward triangular merger may result in an assignment of the target’s assets under the non-assignment provision in question.
The Court noted that if the parties to the license had intended to require consent for the transactions involved in a reverse triangular merger, they could have negotiated for, and included in the license, a change of control provision.
The Court chose not to follow the U.S. District Court for the Northern District of California’s holding in SQL Solutions v. Oracle. In that case, the District Court held that a reverse triangular merger resulted in an assignment by operation of law of a license agreement of the target company (regardless that the target company was the surviving party in the merger). M&A practitioners and drafters of commercial contracts and licenses should be aware that California courts may find that reverse triangular mergers result in an assignment by operation of law.