Delaware and California Courts Split as to Whether a Reverse Triangular Merger Results In an Assignment By Operation of Law, Creating Potential Pitfalls for Delaware and Other Foreign Corporations Located in California

by Sheppard Mullin Richter & Hampton LLP
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In Meso Scale Diagnostics, LLC v. Roche Diagnostics GmbH, C.A. No. 5589-VCP, 2013 WL 911118 (Del. Ch. Feb. 22, 2013, rev. Mar. 8, 2013), the Delaware Court of Chancery held that a reverse triangular merger does not result in an assignment of the assets of the surviving entity by operation of law. Although the Meso Scale Diagnostics decision confirms, at least under Delaware law, the long-standing view of many practitioners that a reverse triangular merger does not result in an assignment by operation of law, it does not directly affect the contrary position taken by the United States District Court for the Northern District of California in SQL Solutions, Inc. v. Oracle Corp., 1991 WL 626458 (N.D. Cal. Dec. 19, 1991), that under California law a reverse triangular merger does constitute an assignment by operation of law. As a result, foreign (i.e., non-California) corporations in California subject to Section 2115 of the California Corporations Code (“Section 2115”) must consider the holdings in Meso Scale Diagnostics and SQL Solutions when analyzing the effect that an acquisitions may have on contractual anti-assignment provisions.

Background

A reverse triangular merger is an acquisition structure whereby one company, the acquirer, creates a subsidiary to acquire a target company. The subsidiary of the acquirer purchases the target and thereafter merges with and into the target company, with the target company surviving the merger. The result of structure is that the target company continues to exist, but as a wholly-owned subsidiary of the acquirer.

SQL Solutions. In 1986, Oracle Corporation entered into a software licensing and services agreement with a software vendor, D&N Systems Inc. Under the terms of that agreement, D&N received rights that were exclusively for its own use and were not to be assigned or transferred to a third party without Oracle’s prior written consent. In 1990, D&N merged with SybaseSub, Inc., with D&N as the surviving corporation, but changing its name to SQL Solutions, Inc. Oracle alleged that the anti-assignment terms of the licensing and services agreement were breached when the rights granted thereunder to D&N were transferred to SQL. D&N claimed that because there was only a change of ownership followed by a name change, no assignment or transfer of rights occurred.

In concluding that under California law a reverse triangular merger constitutes an assignment by operation of law, the SQL Solutions court held that California courts have consistently recognized that an assignment or transfer of rights does occur merely through a change in the legal form of ownership of a business. The SQL Solutions court found that a transfer of rights is no less a transfer because it occurs by operation of law in a merger.

Meso Scale Diagnostics. In 2007, Roche Diagnostics GmbH acquired BioVeris Corporation through a reverse triangular merger, which resulted in BioVeris becoming a wholly-owned subsidiary of Roche. Following the acquisition, Meso Scale Diagnostics, LLC and Meso Scale Technologies, LLC sued Roche alleging that the acquisition violated the anti-assignment clause of a consent agreement to which they were a party because the reverse triangular merger was an assignment by operation of law and their consent was not obtained. Roche moved for summary judgment and argued that there was no assignment by operation of law or otherwise because BioVeris was the surviving party of the merger, and, therefore, BioVeris did not assign anything to Roche.

In granting Roche’s motion, the Delaware Court of Chancery held that Section 259 of the Delaware General Corporation Law supported Roche’s position that “generally, 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.” In doing so, the court explicitly dismissed plaintiffs’ argument that the court should embrace the holding in SQL Solutions that a reverse triangular merger results in an assignment by operation of law. The court stated that if it were to adopt the approach in SQL Solutions, it would conflict with Delaware’s jurisprudence surrounding stock acquisitions. Specifically, the court held that under Delaware law, stock purchase transactions, by themselves, do not result in an assignment by operation of law: Delaware corporations may lawfully acquire the securities of other corporations, and a purchase or change of ownership of such securities is not regarded as assigning or delegating the contractual rights or duties of the corporation whose securities are purchased.

Implications

Foreign Corporations. Section 2115 imposes various requirements of California law on non-California corporations with substantial connections to the state. Specifically, Section 2115 provides that if a corporation is subject to Section 2115, California law trumps the law of the jurisdiction in which such corporation is incorporated with respect to certain matters. The “internal affairs doctrine,” on the other hand, holds that the laws of the state of incorporation should normally govern a corporation’s internal affairs. Internal affairs are described as those “matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders.” Edgar v. MITE Corp., 457 U.S. 624, 645 (1982). Section 2115 and the internal affairs doctrine have created confusion for foreign corporations attempting to comply with conflicting laws of two states. However, the Delaware Supreme Court decision in VantagePoint Venture Partners 1996 v. Examen, Inc., 871 A.2d 1108 (Del. 2005), and the subsequent holding by the California Court of Appeal in Lidow v. Superior Court, 206 Cal. App. 4th 351, 141 Cal. Rptr. 3d 729 (2012), shed some light as to how courts may interpret the holding in Meso Scale Diagnostics as it applies to corporations subject to Section 2115.

VantagePoint. In VantagePoint, the Delaware Supreme Court held that the internal affairs of Delaware corporations are to be decided exclusively in accordance with Delaware law. Specifically, the Court stated that the “internal affairs doctrine is a long-standing choice of law principle which recognizes that only one state should have the authority to regulate a corporation’s internal affairs — the state of incorporation.” The Court also noted that there was a need for certainty and predictability in determining the internal affairs of a corporation and that applying the law of one state over another would result in uncertainty and intolerable confusion. The Court rejected the applicability of Section 2115 and stated that the statute violated the “well-established choice of law rules and the federal constitution mandated that Examen’s internal affairs . . . be adjudicated exclusively in accordance with the law of its state of incorporation.”

Lidow. While the VantagePoint decision provided clarity as to how Delaware courts viewed the conflict between Section 2115 and the internal affairs doctrine, it was not until 2012 in Lidow that the California Court of Appeal suggested that it also agreed with the application of the internal affairs doctrine over Section 2115 in certain contexts. The court in Lidow indicated that the internal affairs doctrine in certain circumstances, such as mergers, consolidations and reorganizations, that involve a corporation’s relationship to its shareholders, trumps the requirements of Section 2115. Specifically, the court noted that the removal of an officer from a corporation for a number of reasons would fall within the internal affairs of corporation, and thus be governed by the laws of the state of incorporation, but the removal of an officer allegedly in retaliation went beyond internal corporate governance and was governed by the law of California, where the alleged wrong occurred.

Impact of Meso Scale Diagnostics. The Meso Scale Diagnostics decision finally clarified that, at least under Delaware law, a reverse triangular merger is not considered an assignment by operation of law. However, the decision did not affect the contrary holding in SQL Solutions. Which decision governs an anti-assignment provision may depend on the purpose of the primary transaction. Under VantagePoint and Lidow, if a reverse triangular merger is conducted for purposes of an internal reorganization, a California court may find that the internal affairs doctrine trumps the requirements of Section 2115. However, if a reverse triangular merger is conducted for purposes that are not integral to the internal affairs of a corporation, a California court may find that the requirements of Section 2115 trump the internal affairs doctrine.

For further information, please contact David Sands at (213) 617-5536 or Amrita Nangiana at (213) 617-5495.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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