By Lucantonio N. Salvi and Marko W. Kipa

A government contracts due diligence encompasses a broad range of statutory, regulatory, and contractual issues. One issue that we always consider is compliance with the Anti-Assignment Act (the “Act”), which prohibits the transfer of a government contract to a third-party. While the Act does not strictly apply to subcontracts, we nevertheless must review them, as well as other agreements (such as teaming agreements), for contractual anti-assignment provisions. This review was facilitated in the past by the widely held view among practitioners that a stock purchase or reverse triangular merger, without more, does not generally result in an assignment and therefore does not require the counterparty’s consent. This is particularly relevant since most sales and purchases of government contractors are structured as stock purchases or reverse triangular mergers (i.e., an acquisition structure in which a subsidiary of the buyer merges into the target company and the target company becomes a wholly-owned subsidiary of the buyer once the merger is consummated).  In both cases, the separate corporate identity of the target company is preserved, and the parties generally avoid the need to obtain Government consent to novate government contracts held by the target company.  The traditionally prevalent view even finds support under federal case law in the context of government contractors. See Appeals of Newport News Shipbuilding & Dry Dock Co., ASBCA Nos. 44731, 44826, 97-1 BCA ¶ 28,835 (holding, among other things, that reverse triangular mergers are stock purchase transactions where the acquired corporations retain their separate corporate existence and in which the acquired company’s contracts are in most cases unaffected).
 

A recent Delaware Chancery Court decision, however, in a ruling on a motion to dismiss, threatened to turn this run-of-the-mill issue on its head in the context of a reverse subsidiary merger. In Meso Scale, the court was confronted, in pertinent part, with the question of whether the defendants breached a contract’s anti-assignment provision by failing to obtain prior written consent in connection with a reverse triangular merger. Meso Scale Diagnostics, LLC v. Roche Diagnostics GmbH, C.A. No. 5589-VCP, 2011 WL 1348438 (Del. Ch. Apr. 8, 2011) (unpublished decision). The Anti-Assignment provision at issue resembled many of the provisions we encounter and analyze during our due diligence:
 

Neither this Agreement nor any of the rights, interests or obligations under this Agreement 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 . . . .

Id. at *5 (emphasis added). The defendants moved to dismiss this count, arguing that a change in control through a reverse triangular merger does not lead to an assignment by operation of law or otherwise. Id. at *7.

The court agreed that the anti-assignment provision on its face addressed only assignments and did not speak to change in control. Id. at *10. The court, however, did not view that fact as dispositive. Id. Rather, it seized upon the language in the provision prohibiting an assignment “by operation of law or otherwise” without prior written consent. Id. The court, thus, went on to discuss whether a reverse triangular merger could give rise to an assignment by operation of law or otherwise. Id.

The court rejected the defendants’ argument that a reverse triangular merger was the equivalent of a stock acquisition. Id. at *11-12. The court acknowledged the case law holding that a stock acquisition without more does not result in an assignment. Id. However, the court did not find the stock acquisition cases controlling and declined to hold that a reverse triangular merger does not lead to an assignment as a matter of law. Id. at *12. The court emphasized that the acquisition in question involved more than a mere change in ownership. Id. Specifically, the court relied on the plaintiffs’ allegation that, following the reverse triangular merger, the defendants laid-off 200 employees, closed the Company’s facility, and informed customers that the Company’s product lines were being discontinued. Id.

Conversely, the court explained that it may still rule against the plaintiffs on the merits at a later stage in the proceedings. Id. at *12-13. The plaintiffs, relying on forward triangular mergers, argued that any merger would constitute an assignment by operation of law. Id. at *12. As it had done with cases addressing stock acquisitions, the court did not find the cases involving forward triangular mergers to be dispositive. Id. at *13. The court also questioned the plaintiffs’ reliance on an unpublished federal district court decision from a non-binding jurisdiction. Id. Nevertheless, the court denied the defendants’ motion to dismiss. Id. at *19.

While the Meso Scale decision may be narrowly limited to the facts of that case (which involved license rights held by biotechnology companies), its reasoning resonates broadly across the M&A realm, including in the government contracts world. The Meso Scale decision (i) underscores the importance of including comprehensive assignment provisions in contracts, and (ii) introduces another element to consider as part of a government contracts due diligence review and evaluation. While many practitioners believe that the Delaware courts – once a decision on the merits is rendered – will likely apply the facts of the Meso Scale decision very narrowly and uphold the previously widely-held view that reverse triangular mergers, without more, do not generally trigger anti-assignment provisions, there can be no assurance in the meantime for sellers or buyers of companies. Rather, the only risk-free option is to require target companies to obtain consents from counterparties (including the Government for prime contracts) to agreements that contain the “offending” anti-assignment clauses. This, however, can often be a daunting and sometimes prohibitive task to getting a deal done. It is also unclear how the Meso Scale opinion will affect, or be interpreted in light of, existing federal case law, such as the decision of the Armed Services Board of Contract Appeals in the Newport News case cited above. Thus, for now, anti-assignment provisions in the context of reverse triangular mergers must be considered carefully in light of the materiality of the relevant contracts, and the issue should be raised with counsel in order to properly address the risks as part of the overall acquisition strategy.

That being said, as noted above, it is important to remember that the court in Meso Scale did not resolve the issue on the merits. The court may still find that the reverse triangular merger did not implicate the anti-assignment provision at issue. Indeed, it is apparent from reading the court’s opinion that the defendants took fairly aggressive (and some would say egregious) actions following the reverse triangular merger. The court may well have reached a different conclusion if only a mere change in ownership was involved. This could prove to be a distinguishing feature in the ultimate analysis, which many M&A practitioners hope, will narrowly construe the decision to the facts in that case. Either way, until such decision is rendered, practitioners and government contractors alike must now face the prospect that a seemingly innocuous anti-assignment provision may have some bite behind its bark.

Authored by:

Lucantonio N. Salvi
(202) 218-0004
lsalvi@sheppardmullin.com

and

Marko W. Kipa
(202) 772-5302
mkipa@sheppardmullin.com