by Ed Batts
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) [an enhanced version of this opinion is available to lexis.com
subscribers] 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
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 U.S. Dist. LEXIS 21097 [enhanced version] 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
The learning points from Meso Scale are as
(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
For more information about choice-of-law provisions,
please contact Ed Batts.
This information is intended as
a general overview and discussion of the subjects dealt with. The information
provided here was accurate as of the day it was posted; however, the law may
have changed since that date. This information is not intended to be, and
should not be used as, a substitute for taking legal advice in any specific
situation. DLA Piper is not responsible for any actions taken or not taken on
the basis of this information.
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