The Delaware Court of Chancery shook the M&A world in 2011 when it defied conventional wisdom by holding that a reverse triangular merger may result in an assignment by operation of law if the buyer converts the target into a mere shell. In a recent decision by the same court in the same case, however, the court confirmed that a reverse triangular merger does not result in an assignment by operation of law, regardless of the ultimate fate of the target.
Deal lawyers frequently use reverse triangular mergers, a transaction structure in which a buyer forms a subsidiary that merges into the target with the target surviving and becoming a subsidiary of the buyer. Before the 2011 decision, it was generally believed that a key advantage of such a structure was that it did not result in an assignment of the target’s contracts by operation of law. This interpretation minimized the likelihood that a consent to the transaction would be required from a counterparty to a contract.
In the recent Delaware decision, however, after examining the reasonable expectations of the parties and applying §259 of the DGCL, the court concluded that the target in a reverse triangular merger does not assign any of its assets by operation of law by merely participating in the merger.
The court distinguished reverse triangular mergers from forward mergers, noting that the target in a forward merger does not survive the merger and assigns its assets by operation of law to the surviving entity. The court also refused to follow the reasoning of a California federal court, which found that a reverse triangular merger can result in an assignment depending on whether the merger affects the interests of the parties to the contract.
The court concluded its analysis by reasoning that a “change of control” provision would have better suited the plaintiff in lieu of an “assignment by operation of law” provision. This case serves as a good reminder to consider the effect of future transactions when negotiating key contracts.