“Do we need a novation?” That is the question invariably asked by the buyer when acquiring a government contractor. Relying on well-established Delaware case law governing acquisitions by stock purchase, a February 22, 2013 Delaware Chancery Court decision, Meso Scale Diagnostics v. Roche Diagnostics, held that a reverse triangular merger did not affect an assignment, by operation of law or otherwise, of the target’s contractual rights.1 This holding should be read to affirm, at least under Delaware corporate law, that a contract transferred by a reverse triangular merger is not subject to the Anti-Assignment Act, and thus does not trigger the novation requirements in Part 42 of the Federal Acquisition Regulation (FAR). Other transfers by “operation of law,” which generally have been found not to require formal FAR novations, should not be affected by the court’s decision.
In a reverse triangular merger, the buyer creates a subsidiary for the sole purpose of purchasing the target company and then merging into the target after the deal closes. Companies often prefer reverse triangular mergers to more direct transactions, because the buyer in a reverse triangular merger historically has been able to obtain control of the target’s otherwise non-transferable assets and contracts without consent from third parties who have contractual relationships with the target company.
Indeed, that was the issue in the Meso Scale Diagnostics case, in which a foreign holding company acquired a license for sophisticated diagnostic technology through a reverse triangular merger. Two Delaware companies with rights to the same technology sued on grounds that the merger resulted in an assignment that required their consent under an anti-assignment provision in the license. The defendants countered that the transfer of the license resulting from the reverse triangular merger was not subject to the antiassignment provision in the license agreement, because the target company that held the rights survived the transaction. The Chancery Court granted summary judgment to the defendants on grounds that relevant Delaware jurisprudence, holding that a mere change in the legal ownership of a business does not result in an assignment by operation of law, was controlling. The court found that a reverse triangular merger, like a stock purchase, does not result in a change in the target company’s corporate form.
Although FAR Subpart 42.12 specifically distinguishes stock purchases (which do not require novations) from asset purchases (which generally do), it does not explicitly address novation requirements in the context of a merger. The Meso Scale Diagnostics decision appears to solidify for government contractors the general practice of treating reverse triangular mergers as tantamount to stock purchases, i.e., no novation required.
Government contractors should not be concerned about the court’s conclusion that reverse triangular mergers do not result in assignment by operation of law. The Chancery Court’s holding should have no bearing on other transfers by operation of law, which are covered by the “operation of law” exception to the Anti-Assignment Act. Courts and the boards of contract appeals have carved out exceptions by which a contractor may transfer its agreements with the U.S. Government to a third-party successor-in-interest “by operation of law,” such as through a merger, consolidation, or corporate reorganization.2 Accordingly, the FAR provides that novation agreements with the Government are unnecessary when the contract transfer results from a change in contractor ownership by operation of law, i.e., “with no legal change in the contracting party, and when that contracting party remains in control of the assets and is the party performing the contract.” FAR 42.1204(b).
For example, the operation of law exception has been found to cover corporate reorganizations affected by a bankruptcy court order. The U.S. Court of Federal Claims, the Government Accountability Office, and the boards of contract appeals have largely held that the Anti-Assignment Act does not apply to contracts transferred to receivers, debtors-in-interest, trustees, or successors-in-interest.3 Similarly, the operation of law exception should still apply in the context of corporate reorganization or voluntary changes in business form, such as a conversion from a corporation into a limited liability company. Under applicable Delaware statutes, conversions occur by operation of law, and, therefore, should be exempt from the Anti-Assignment Act.4 (The FAR does not explicitly address conversions, and the Government in some instances has required shortform novation or change-of-name agreements before it was willing to recognize the new entity as the contractor’s successor-in-interest.) The Delaware Chancery Court’s discussion of “operation of law” transfers in the Meso Scale Diagnostics decision should have no affect on FAR novation requirements in these contexts.