Delaware Court of Chancery Rules That License Agreement Provision Prohibiting Assignment by Operation of Law May Apply to a Reverse Triangular Merger

April 26, 2011

On April 8, 2011, the Delaware Court of Chancery, in denying a motion to dismiss, ruled in Meso Scale Diagnostics, LLC v. Roche Diagnostics GmbH, C.A. No. 5589-VCP (Del. Ch. 2011) that there may be circumstances where a provision prohibiting assignment of an agreement by operation of law could be triggered by a reverse triangular merger.  In a reverse triangular merger, a wholly owned subsidiary of the acquiring party merges into the target with the target surviving the merger as a wholly owned subsidiary of the acquiring party.   

Background

The case involved a series of agreements relating to rights to use electrochemiluminescence ("ECL") technology that is used in drug research, human diagnostics and other similar applications and in which the defendant Roche Diagnostics GmbH, C.A. ("Roche") had sought to acquire rights after an earlier license that it had received to the technology from the original owner of the technology had been terminated as a result of Roche’s breach.  In a very complex series of transactions in 2003, Roche acquired a limited non-exclusive license to ECL technology in connection with the transfer of the ECL technology to a newly formed entity named BioVeris Corporation.  The Plaintiffs in the litigation, Meso Scale Diagnostics, LLC ("MSD") and Meso Scale Technologies, LLC ("MST"), holders of certain exclusive license rights in the ECL technology, consented to this transaction.  Thereafter, in 2007, after a dispute arose between Roche and BioVeris over whether Roche’s use of ECL technology exceeded the scope of its limited license, Roche acquired BioVeris through a reverse triangular merger.

On June 22, 2010, the Plaintiffs filed a complaint alleging that Roche’s acquisition of BioVeris violated the anti-assignment clause found in the 2003 agreement in which the Plaintiffs had consented to Roche’s acquisition of a limited license of the ECL technology.  The anti-assignment clause that the Plaintiffs alleged was breached stated as follows:

Neither this Agreement nor any of the rights, interests or obligations under [it] shall be assigned, in whole or in part, by operation of law or otherwise by any of the parties without the prior written consent of the other parties. . .

Construction of Anti-Assignment Clause

Roche filed a motion to dismiss for failure to state a claim asking the court to reject the Plaintiffs’ claims that the anti-assignment provision had been breached as a result of the reverse triangular merger by which BioVeris had been acquired by Roche.  In its motion, Roche argued that the anti-assignment clause did not contain a provision that a change in ownership or control is deemed to constitute an assignment.  Moreover, Roche argued that, in the reverse triangular merger by which Roche acquired BioVeris, nothing was assigned to Roche and, as in a stock acquisition, BioVeris’ rights and obligations remained intact upon consummation of the merger.  Thus, Roche contended that, unlike in the context of a forward triangular merger, where the target company does not survive and a clause prohibiting assignment "by operation of law" would be triggered, no assignment "by operation of law" occurred in the acquisition of BioVeris.  Instead, Roche urged that the only thing that had changed in the transaction was the ownership of BioVeris and thus the anti-assignment clause could not have been triggered by the merger. 

The Plaintiffs countered with the argument that an assignment "by operation of law" includes all mergers, regardless of their form.  In support of their argument, the Plaintiffs cited two Delaware cases, Tenneco Auto Inc. v. El Paso Corporation., 2002 WL 453930 (Del. Ch. 2002) and Star Cellular Telephone Company v. Baton Rouge CGSA, Inc., 19 Del. J. Corp. L. 875 (Del. Ch. 1993) in which the courts had noted that a merger is considered an assignment by operation of law, however those cases involved forward mergers.  Additionally, the Plaintiffs also relied on the unreported California federal court decision, SQL Solutions Inc. v. Oracle Corporation, 1991 WL 626458 (N.D. Cal. Dec. 19, 1991), that held that an anti-assignment provision in a software license agreement that did not contain a change of ownership or control provision was triggered by a reverse triangular merger and that the software licensor’s consent to the assignment was required as a matter of federal copyright law. The Court gave the SQL Solutions case limited weight, however, because it was a decision from another jurisdiction, it was non-binding in that jurisdiction given that it was an unreported decision and "the court’s reasoning [was] open to question."[1]

In making its decision in Meso Scale Diagnostics, LLC v. Roche Diagnostics GmbH, the Court agreed that the clause in question did not contain a change in ownership or control provision, but found that this, by itself, did not necessarily mean that the merger could not have constituted an assignment by operation of law for purposes of the clause.  Next, the Court noted that no Delaware case has squarely addressed the issue of whether a reverse triangular merger could be viewed as an assignment by operation of law under any circumstances.  The Court then explained that, in considering the Defendant Roche’s motion to dismiss, the Court was required to assume the truthfulness of the Plaintiffs’ allegations and afford the Plaintiffs "the benefit of all reasonable inferences."  Finding that the anti-assignment contractual language contained in the Global Consent was not "clear and unambiguous," the Court declared that it could grant Roche’s motion to dismiss only if Roche’s interpretation of the anti-assignment clause was the only reasonable construction as a matter of law.

The Court stated that, although Roche’s construction of the "by operation of law" language was reasonable, "it is not necessarily the only reasonable interpretation" and that in this early stage of litigation it must deny Roche’s motion to dismiss.  Citing several Delaware cases, including Baxter Pharmaceutical Products, Inc. v. ESI Lederle Inc., 1999 WL 160148 (Del. Ch. 1999) and Branmar Theatre Company v. Branmar, Inc., 264 A.2d 526 (Del. Ch. 1970), the Court agreed that stock acquisitions do not, in and of themselves, constitute an assignment because the change of ownership of securities is not regarded as assigning or delegating any contractual rights or duties of the acquired corporation.  While the Court acknowledged similarities between stock acquisitions and reverse triangular mergers, the Court concluded that they are not the same, and thus the analogy does not control.  Stock acquisitions, the Court noted, "exemplify a situation where a mere change in ownership, without more, does not constitute an assignment as a matter of law."  However, the Court noted that the Plaintiffs had alleged that the transaction in question involved more than just a change of ownership, pointing to the Plaintiffs’ allegations that, within months of the merger, all of the target BioVeris’s 200 employees were laid off, its Maryland facility was closed and its existing customers were notified that its product lines were being discontinued.  These additional circumstances, in the Court’s view, created a plausible argument "that ‘by operation of law’ was intended to cover mergers that effectively operated like an assignment, even if it might not apply to mergers merely involving changes of control."  Thus, at this early stage in the litigation with no factual record, the Court decided that it lacked sufficient evidence to choose between what it considered two reasonable constructions of a contract.

Conclusion

Although this ruling arose in the context of a motion to dismiss based on the pleadings, this ruling is noteworthy because it calls into question the widely held view that a reverse triangular merger does not involve any assignment by the target and therefore never can trigger an anti-assignment clause prohibiting an assignment by operation of law.  One of the more troubling aspects of the Court’s decision is the Court’s willingness to consider the Plaintiff’s argument that Roche’s post-acquisition dealings with BioVeris, i.e., the layoffs and closure of the BioVeris facility, are relevant in deciding whether an assignment occurred when the merger was consummated.  However, in footnote 96, the Court may have signaled how it may ultimately rule when it recognized the well-settled law of independent legal significance and stated that "these principles may prove important in the ultimate resolution of this dispute."

In a reverse triangular merger context, acquirors that desire to avoid any risk associated with anti-assignment clauses of uncertain scope may decide it is prudent to require that a consent be obtained from the third party, particularly where a license or other agreement containing such a clause is important to the target’s business.