Reverse Triangular Mergers

Contracts may represent the most important assets of a corporation. The counterparties to those contracts, wary of changes in the identity of the corporation that could follow an M&A transaction, usually seek to restrict those changes by negotiating anti-assignment clauses.

Anti-Assignment Clauses

Contractual anti-assignment clauses take a variety of forms: Some simply prohibit assignments of the contract without the prior consent of the counterparty; others also require counterparty consent before the contract may be assigned “by operation of law”; and still others also require counterparty consent whenever the target corporation undergoes a “change of control” of one form or another.

Thus, one of the many issues driving the structuring of an M&A transaction is its impact on anti-assignment clauses contained in the key business contracts of the target corporation. M&A practitioners have a number of different means for structuring an acquisition of a target corporation, including:

An acquisition of assets, in which the acquiring corporation buys only the assets (and assumes certain liabilities) of the target corporation and the target corporation stockholders retain their ownership interests in the target corporation;

An acquisition of stock, in which the target corporation becomes as a wholly owned subsidiary of the acquiring corporation;

A forward triangular merger, in which the target corporation merges into a newly created subsidiary of the acquirer and the newly created subsidiary survives as a wholly owned subsidiary of the acquiring corporation; and

A reverse triangular merger, in which a newly created subsidiary of the acquirer merges into the target corporation and the target corporation survives as a wholly owned subsidiary of the acquiring corporation.

Background

In 2011, in the course of denying a motion to dismiss in Meso Scale Diagnostics, LLC v. Roche Diagnostics GMBH, C.A. No. 5589-VCP (Del. Ch. Apr. 8, 2011), Vice Chancellor Donald F. Parsons of the Delaware Court of Chancery discussed the operation of an anti-assignment clause prohibiting assignments “by operation of law or otherwise” in the context of various acquisition structures.

In the case of a stock acquisition, the Vice Chancellor explained that a purchase by an acquiring corporation of the stock of a target corporation directly from its stockholders “exemplif[ies] a situation in which a mere change of ownership, without more, does not constitute an assignment as a matter of law.” As such, “courts in this State and elsewhere have held that '[w]here an acquiror purchases stock of a corporation, that purchase does not, in and of itself, constitute an 'assignment' to the acquiror of any contractual rights or obligations of the corporation whose stock is sold.'” One could presumably take this analysis a step further by concluding that a stock acquisition also would not trigger a simple anti-assignment clause that does not specifically mention assignments by operation of law or changes of control.'

In contrast, the Vice Chancellor noted that because in a forward triangular merger, “the target company is not the surviving entity and its rights, interests, and obligations vest in the surviving entity,” Delaware courts have determined that this transaction structure does represent an assignment of the target corporation's contracts and other assets by operation of law, thereby requiring the consent of the counterparty.

Recognizing that the Court of Chancery “apparently has not yet confronted this issue,” the Vice Chancellor left unanswered the question of whether a reverse triangular merger constitutes an assignment of the target corporation's assets “by operation of law or otherwise.” While acknowledging that reverse triangular mergers are “similar in some respects” to stock acquisitions because, in both scenarios, the acquirer becomes the owner of all of the stock of the target corporation, the Vice Chancellor also noted that after the merger in question was completed, the target corporation “was gutted and converted into a shell corporation for [the acquirer's] benefit.” This factor was sufficient for the Vice Chancellor to require a hearing on the merits to determine whether the merger “resulted in more than a mere change in control” with respect to which “the parties intended to require [the other contracting party's] consent in this situation by using the term 'by operation of law.'”

Two years later, acting on a motion for summary judgment in the same litigation, the Vice Chancellor tackled head-on the question he had left open at the preliminary motions stage, concluding that a reverse triangular merger “generally is not an assignment by operation of law or otherwise ' .” Meso Scale Diagnostics, LLC v. Roche Diagnostics GMBH, C.A. No. 5589-VCP (Del. Ch. Feb. 22, 2013). Without mentioning the concern expressed in his earlier ruling as to the post-merger disposition of the target corporation's assets, the Vice Chancellor stated simply that “mergers do not result in an assignment by operation of law of assets that began as property of the surviving entity and continued to be such after the merger.” [emphasis added]

The Vice Chancellor found support for his ruling in previous Delaware cases that concluded that forward triangular mergers “result[ ] in the transfer of the non-surviving corporation's rights and obligations to the surviving corporation by operation of law.” As such, section 259 of the Delaware General Corporation Law, which provides that “the separate existence of all the constituent corporations ' except the one into which the ' others ' have been merged ' shall cease,” “suggests that the surviving corporation would not have effected any assignment.” The Vice Chancellor also found this interpretation to be “consistent with the reasonable expectation of the parties,” as well as “the vast majority of commentary” and the views of “[l]eading commentators.” Finally, the Vice Chancellor rejected the argument that the reverse triangular merger resulted in the acquiring corporation effectively owning the assets of the target corporation, albeit through a wholly owned subsidiary, explaining instead that Delaware's “longstanding doctrine of independent legal significance” may be “applied in situations where deals are structured so as to avoid consent rights.”

In the final analysis, the Vice Chancellor rejected conflicting precedents issued by courts of other states and concluded that “[b]oth stock acquisitions and reverse triangular mergers involve changes in legal ownership, and the law should reflect parallel results” in the context of contractual anti-assignment clauses. In the Vice Chancellor's view, a counterparty that “could have negotiated for a 'change of control provision'” but failed to do so is no position to argue that a provision that simply prohibits assignments of the contract, whether “by operation of law or otherwise,” was intended to implicate a statutory merger in which the other contracting party is the surviving entity.

Conclusion

Vice Chancellor Parson's recent ruling in Meso Scale Diagnostics, LLC v. Roche Diagnostics GMBH provides much welcomed clarification that the typical reverse triangular merger does not constitute an assignment of a target corporation's contracts “by operation of law or otherwise.” By drawing a clear distinction between stock purchases and reverse triangular mergers, on the one hand, and forward triangular mergers, on the other, the Vice Chancellor has provided M&A deal planners with a useful strategy for avoiding contractual anti-assignment provisions where a stock acquisition is not available or practical. Of course, transactions utilizing mixed cash and stock consideration may still be required to be structured as forward triangular mergers for tax planning purposes despite the consequences under anti-assignment clauses in contracts of the target corporations. And, going forward, if a party to a contract wants to insure that it has consent rights over transactions that might result in a change in the identity of its counterparty, it had better make sure that the anti-assignment clause incorporates a change of control feature.

Robert S. Reder has been serving as a consulting attorney at Milbank, Tweed, Hadley & McCloy LLP since his retirement as a partner in April 2011. A member of this newsletter's Board of Editors, Mr. Reder also serves as an Adjunct Professor at Vanderbilt Law School and at Fordham Law School.

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Contracts may represent the most important assets of a corporation. The counterparties to those contracts, wary of changes in the identity of the corporation that could follow an M&A transaction, usually seek to restrict those changes by negotiating anti-assignment clauses.

Anti-Assignment Clauses

Contractual anti-assignment clauses take a variety of forms: Some simply prohibit assignments of the contract without the prior consent of the counterparty; others also require counterparty consent before the contract may be assigned “by operation of law”; and still others also require counterparty consent whenever the target corporation undergoes a “change of control” of one form or another.

Thus, one of the many issues driving the structuring of an M&A transaction is its impact on anti-assignment clauses contained in the key business contracts of the target corporation. M&A practitioners have a number of different means for structuring an acquisition of a target corporation, including:

An acquisition of assets, in which the acquiring corporation buys only the assets (and assumes certain liabilities) of the target corporation and the target corporation stockholders retain their ownership interests in the target corporation;

An acquisition of stock, in which the target corporation becomes as a wholly owned subsidiary of the acquiring corporation;

A forward triangular merger, in which the target corporation merges into a newly created subsidiary of the acquirer and the newly created subsidiary survives as a wholly owned subsidiary of the acquiring corporation; and

A reverse triangular merger, in which a newly created subsidiary of the acquirer merges into the target corporation and the target corporation survives as a wholly owned subsidiary of the acquiring corporation.

Background

In 2011, in the course of denying a motion to dismiss in Meso Scale Diagnostics, LLC v. Roche Diagnostics GMBH, C.A. No. 5589-VCP (Del. Ch. Apr. 8, 2011), Vice Chancellor Donald F. Parsons of the Delaware Court of Chancery discussed the operation of an anti-assignment clause prohibiting assignments “by operation of law or otherwise” in the context of various acquisition structures.

In the case of a stock acquisition, the Vice Chancellor explained that a purchase by an acquiring corporation of the stock of a target corporation directly from its stockholders “exemplif[ies] a situation in which a mere change of ownership, without more, does not constitute an assignment as a matter of law.” As such, “courts in this State and elsewhere have held that '[w]here an acquiror purchases stock of a corporation, that purchase does not, in and of itself, constitute an 'assignment' to the acquiror of any contractual rights or obligations of the corporation whose stock is sold.'” One could presumably take this analysis a step further by concluding that a stock acquisition also would not trigger a simple anti-assignment clause that does not specifically mention assignments by operation of law or changes of control.'

In contrast, the Vice Chancellor noted that because in a forward triangular merger, “the target company is not the surviving entity and its rights, interests, and obligations vest in the surviving entity,” Delaware courts have determined that this transaction structure does represent an assignment of the target corporation's contracts and other assets by operation of law, thereby requiring the consent of the counterparty.

Recognizing that the Court of Chancery “apparently has not yet confronted this issue,” the Vice Chancellor left unanswered the question of whether a reverse triangular merger constitutes an assignment of the target corporation's assets “by operation of law or otherwise.” While acknowledging that reverse triangular mergers are “similar in some respects” to stock acquisitions because, in both scenarios, the acquirer becomes the owner of all of the stock of the target corporation, the Vice Chancellor also noted that after the merger in question was completed, the target corporation “was gutted and converted into a shell corporation for [the acquirer's] benefit.” This factor was sufficient for the Vice Chancellor to require a hearing on the merits to determine whether the merger “resulted in more than a mere change in control” with respect to which “the parties intended to require [the other contracting party's] consent in this situation by using the term 'by operation of law.'”

Two years later, acting on a motion for summary judgment in the same litigation, the Vice Chancellor tackled head-on the question he had left open at the preliminary motions stage, concluding that a reverse triangular merger “generally is not an assignment by operation of law or otherwise ' .” Meso Scale Diagnostics, LLC v. Roche Diagnostics GMBH, C.A. No. 5589-VCP (Del. Ch. Feb. 22, 2013). Without mentioning the concern expressed in his earlier ruling as to the post-merger disposition of the target corporation's assets, the Vice Chancellor stated simply that “mergers do not result in an assignment by operation of law of assets that began as property of the surviving entity and continued to be such after the merger.” [emphasis added]

The Vice Chancellor found support for his ruling in previous Delaware cases that concluded that forward triangular mergers “result[ ] in the transfer of the non-surviving corporation's rights and obligations to the surviving corporation by operation of law.” As such, section 259 of the Delaware General Corporation Law, which provides that “the separate existence of all the constituent corporations ' except the one into which the ' others ' have been merged ' shall cease,” “suggests that the surviving corporation would not have effected any assignment.” The Vice Chancellor also found this interpretation to be “consistent with the reasonable expectation of the parties,” as well as “the vast majority of commentary” and the views of “[l]eading commentators.” Finally, the Vice Chancellor rejected the argument that the reverse triangular merger resulted in the acquiring corporation effectively owning the assets of the target corporation, albeit through a wholly owned subsidiary, explaining instead that Delaware's “longstanding doctrine of independent legal significance” may be “applied in situations where deals are structured so as to avoid consent rights.”

In the final analysis, the Vice Chancellor rejected conflicting precedents issued by courts of other states and concluded that “[b]oth stock acquisitions and reverse triangular mergers involve changes in legal ownership, and the law should reflect parallel results” in the context of contractual anti-assignment clauses. In the Vice Chancellor's view, a counterparty that “could have negotiated for a 'change of control provision'” but failed to do so is no position to argue that a provision that simply prohibits assignments of the contract, whether “by operation of law or otherwise,” was intended to implicate a statutory merger in which the other contracting party is the surviving entity.

Conclusion

Vice Chancellor Parson's recent ruling in Meso Scale Diagnostics, LLC v. Roche Diagnostics GMBH provides much welcomed clarification that the typical reverse triangular merger does not constitute an assignment of a target corporation's contracts “by operation of law or otherwise.” By drawing a clear distinction between stock purchases and reverse triangular mergers, on the one hand, and forward triangular mergers, on the other, the Vice Chancellor has provided M&A deal planners with a useful strategy for avoiding contractual anti-assignment provisions where a stock acquisition is not available or practical. Of course, transactions utilizing mixed cash and stock consideration may still be required to be structured as forward triangular mergers for tax planning purposes despite the consequences under anti-assignment clauses in contracts of the target corporations. And, going forward, if a party to a contract wants to insure that it has consent rights over transactions that might result in a change in the identity of its counterparty, it had better make sure that the anti-assignment clause incorporates a change of control feature.

Robert S. Reder has been serving as a consulting attorney at Milbank, Tweed, Hadley & McCloy LLP since his retirement as a partner in April 2011. A member of this newsletter's Board of Editors, Mr. Reder also serves as an Adjunct Professor at Vanderbilt Law School and at Fordham Law School.

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