Court Decision Casts Doubt on Whether Reverse Triangular Mergers May Constitute “Assignment by Operation of Law”
February 22, 2013
Reverse triangular mergers are a common M&A transaction structure in which an acquiring entity will create a shell subsidiary to be merged with and into a target company with the target company’s owners receiving stock or equity consideration in exchange for their ownership interests in the target company. Under this structure, the target company becomes a subsidiary of the acquiring entity. Reverse triangular mergers have traditionally been assumed to have advantages over other transactional transaction structures including (1) usually requiring the approval of less than all of the target company’s owners, and (2) having the target company continue to survive and exist, which reduces the need to assign contracts of the target company, among other things. However, an April 8, 2011 Delaware Chancery Court decision, Meso Scale Diagnostics v. Roche Diagnostics, has cast some doubt on whether contracts do not need to be assigned following a reverse triangular merger.
In the Meso Scale Diagnostics case, there was controversy over whether a reverse triangular merger constituted an “assign[ment] … by operation of law or otherwise” for purposes of a license agreement relating to certain proprietary technology. While opining that Delaware law is clear that a stock purchase agreement (another, more common, M&A transaction structure) would not constitute an assignment by operation of law, the Delaware Chancery Court declined to grant a motion to dismiss the case. This was based on the argument that a reverse triangular merger was similarly not an assignment by operation of law, ruling that a question on that matter still existed given (1) the lack of clear precedent on the subject under Delaware law, and (2) some indications of the intent of the parties, particularly the decision by the acquiring entity after the transaction to terminate all the employees of the acquired entity and abandon nearly all of the acquired entity’s assets. The court further cited an unpublished federal court decision in the Northern District of California, SQL Solutions, Inc. v. Oracle Corp., where a similar decision was reached.
Although the Meso Scale Diagnostics decision was made only at the motion to dismiss stage of the litigation, and although the decision was founded upon a particular and unique fact pattern, the Meso Scale Diagnostics case has introduced uncertainty to the traditional assumption of legal professionals that a reverse triangular merger produces much of the same legal effect as a stock purchase transaction. Specifically, the decision has introduced doubt that contracts of the target entity do not need to be assigned to the acquiring entity in a reverse triangular merger, given the continuing existence of the target entity.
In light of the Meso Scale Diagnostics decision, M&A practitioners should exercise caution with regard to the use of reverse triangular mergers, including giving particular attention to the assignability of contracts and the intentions of the acquiring entity after the consummation of the transaction. Further, until Delaware law provides greater clarity on the topic, contract drafters should be aware of the potential effect of the use of the language “assignment by operation of law” in the assignment provisions of contracts, lest such language produce results contrary to the intent of the parties.