A recent decision by the Ohio Supreme Court presents another challenge to the widely understood rule of corporate law that in a merger of corporations or other business entities, the existing rights and obligations of the constituent or target companies continue in force, especially their valuable contract rights and obligations. This fundamental principle has come under attack from competing public policy considerations, particularly involving employment and intellectual property contracts. Companies engaging in mergers and acquisitions accordingly need to take particular care that contracts in these and other business-critical areas are properly conveyed and continue to be enforceable upon completion of a transaction.
In Acordia of Ohio LLC v. Fishel, the surviving company in a merger sued employees of the acquired company to enforce noncompetition agreements they had entered into some years earlier when the employees left to join a competitor. The Ohio Supreme Court, by a 4-3 margin, blocked that effort on May 24, 2012, holding that the merger of two companies effectively terminated the existence of the acquired company, thereby terminating the agreements and causing the two-year noncompetition period to begin running. The noncompetition agreements referred specifically to the acquired company by name, but did not include a clause making them applicable to the company’s legal successors and assigns. Because more than two years had passed following the merger before the employees left the company, the passage of time had released the employees from their noncompetition obligations, and accordingly, the surviving company’s lawsuit failed.
The surviving entity in the merger argued, in accordance with the state merger statute, that the rights and obligations of the constituent company continued uninterrupted as a matter of law, and the employee contracts remained in force after the merger. The two-year covenant therefore should have commenced on the date the employees left the surviving entity, not the date of the merger.
The court’s ruling might surprise some corporate lawyers, who would point to the Ohio merger statute, Section 1701.82 of the Ohio General Corporation Law, which provides that a surviving entity in a merger continues to possess, by operation of the merger, “without further act or deed,” all assets, property, interests and obligations of the constituent entities to the merger. In fact, most corporate lawyers would understand that the constituent entities’ existence continues uninterrupted following the merger, embodied in the surviving entity. This view was pointed out in one of the dissenting opinions in the Acordia case, and numerous other courts have reached this conclusion
Nonetheless, the Acordia decision hearkens back to a 2009 decision by United States Court of the Appeals for the Sixth Circuit. In Cincom v. Novelis, the Sixth Circuit ruled that a merger of two entities invalidated certain license rights to intellectual property held by one of the constituent entities. The court’stheory appears to be similar to that in the Acordia case, namely that the entity holding the license rights ceased to exist as a result of the merger, so the rights had to be “assigned” to the surviving entity by operation of law. The license agreement prohibited such an assignment without consent of the licensor, which consent had not been given. The result in Cincom was even more surprising because the constituent entities to the merger were owned by the same parent company so there was no actual change of beneficial ownership of the companies.
A common theme in these cases seems to be that rights of a special or personal nature were involved. These types of contract rights generally are not transferable absent an express agreement of the parties. Courts construe noncompetition covenants narrowly for public policy reasons. Accordingly, the majority of the Ohio Supreme Court in Acordia was unwilling to extend the covenants where the employees had not agreed specifically that they would survive following the employer’s merger with another company. Similarly, a license of intellectual property was viewed by the Sixth Circuit as fundamentally linked to the nature and identity of the company receiving the license, so that any change in the corporate structure of the licensee resulted in termination of the license, absent an express agreement to the contrary.
Not all state and federal courts would agree with the Acordia and Cincom decisions. However, in both cases, specific language in the agreements allowing assignment and providing that the rights granted would survive an assignment, merger, consolidation, sale of shares or other change in control of the company could have preserved the rights for the successor company. Until there is a firmer consensus around the country, parties would be prudent to include such language in their agreements to protect these valuable contract rights in the event of subsequent corporate structural or ownership changes. Companies should consider renewing any existing employee noncompetition agreements to include appropriate succession language. Acquiring companies should be particularly attentive during due diligence so they are not unpleasantly surprised about the scope of contractual rights they are acquiring.