Negotiation fatigue is an age-old problem in completing any contract – and often, whether fair or not, the further back in the document the clause is positioned, the greater the fatigue.
A choice-of-law provision, which decides which jurisdiction’s law shall govern the contract, is almost always near the last clause in a contract. How often have dueling sets of lawyers (and more frequently, frazzled and puzzled clients who simply want a contract done before the end of the quarter) exhausted themselves on other provisions, only to trade away choice of law for a perceived gain elsewhere in the document?
Delaware Vice Chancellor Donald Parson’s February 22 decision in Meso Scale Diagnostics vs. Roche Diagnostics (Delaware C.A. No. 5589-VCP) highlights how important this seemingly mundane provision can be years later in a change-of-control situation. It also highlights a potentially critical divergence between Delaware and California state law.
Because most California technology companies are incorporated in Delaware, Delaware often is seen as a harmless compromise in choice-of-law provisions, particularly when the counterparty is located in another state, because such counter-party may also be incorporated in Delaware, or overseas, where Delaware’s reputation for business efficiency may be known.
However, electing to use Delaware law may be good for a counterparty undergoing a change of control – and less than optimal for a counterparty that believes it may have negotiated for protection in case the other side in the contract is acquired (for instance, by a competitor).
At specific issue in Meso Scale was whether generic language prohibiting an assignment of the contract (including by “operation of law”) is triggered if a reverse triangular merger is consummated, which is the mechanism by which the vast majority of mergers are structured. In this paradigm, a wholly owned shell subsidiary of a buyer parent corporation merges with and into the target; the target company thus survives intact and it becomes a wholly owned subsidiary of the parent post-closing. To avoid the potential ambiguity of this structure’s effect on a third party’s contract with the target company, sophisticated parties often specifically insert provisions into agreements requiring a consent in the event of a “change of control” in the contracting entity, i.e. the target company, or any corporate parent entity. The Meso Scale case examines what happens when such specific language has been excluded.
This question is important in mergers where triggering an anti-assignment clause may entail either seeking the counterparty’s consent (i.e., customer, supplier or IP licensor’s consent) to the transaction pre-closing, thereby resulting in potential delay as well as lending considerable leverage to the counter-party, or the buyer assuming risk that the contract (which may be instrumental to the operation and thus value of the target business) is invalid post-closing.
In Meso Scale, Vice Chancellor Parsons first affirmed that in Delaware a reverse triangular merger is not considered an assignment, including “by operation of law.” Equally interesting is that he further parsed through California law to demonstrate how California cases would seem to indicate a general assignment clause (with or without “by operation of law” verbiage) is in fact triggered by a reverse triangular merger. In particular, he cited the unpublished 1991 Northern District of California federal court decision in SQL Solutions vs. Oracle Corporation (1991 WL 626458) in which the federal court applied California law to declare that a reverse triangular merger constitutes assignment. Absent a future specific California state court case on the subject to add clarity, it remains uncertain that contracting parties using California law should assume that general anti-assignment clauses will be triggered by reverse triangular mergers.
The learning points from Meso Scale are as follows:
(1) When negotiating contracts, in order to gain full consent protection in a change of control, include explicit, actual language that the contract is void on a change of control of the contracting entity. Such standard language captures the reverse triangular acquisition context. This means a slightly longer contract, but also a clearer understanding between both parties up front, rather than confusion years later when an acquisition of one party is under way. If avoiding a change-of-control clause is absolutely necessary in order to convince the counterparty to enter the contract, then evaluate the choice of law and its repercussions on future assignment.
(2) When involved in a potential change of control, continue to keenly evaluate contract consent provisions – and the choice of law of these contracts. Such diverging terms can mean the difference between an awkward pre-closing consent process (or worse, the scuttling of a deal) and a smooth and speedy closing.
For more information about choice-of-law provisions, please contact Ed Batts.