Business Law Developments
Article Date: Thursday, November 03, 2011
Written By: Thomas J. Molony
You Might Do Well Just to Survive
The Delaware Chancery Court considered, as a matter of first impression, whether a reverse triangular merger constituted an assignment "by operation of law" for purposes of a contractual anti-assignment provision. Meso Scale Diagnostics, LLC v. Roche Diagnostics GmbH, No. 5589-VCP, 2011 WL 1348438 (Del. Ch. Apr. 8, 2011). The court concluded that, depending on the circumstances, a contract term referring to assignment "by operation of law" could be interpreted to include a reverse triangular merger.
In 1995, Meso Scale Technologies, LLC ("MST") and IGEN International, Inc. ("IGEN") formed Meso Scale Diagnostics, LLC ("MSD") as a joint venture to develop the parties' electrochemiluminescence ("ECL") intellectual property. As a contribution to the joint venture, IGEN granted MSD a broad, exclusive, worldwide, royalty-free license for IGEN's ECL technology. The MSD license excluded technology subject to exclusive licenses IGEN previously granted to others, but provided that the excluded technology would become subject to the MSD license if and when the prior third-party licenses terminated or became nonexclusive.
In 1992, IGEN had granted a narrow license for its ECL technology to a company that later was acquired by Roche Holding Ltd. or one of its affiliates (collectively, "Roche"). The United States Court of Appeals for the Fourth Circuit ruled in 2003, however, that IGEN could terminate the Roche license. In response, Roche orchestrated a series of transactions with IGEN, MST and MSD to preserve rights in IGEN's ECL technology. As a part of Roche's plan, IGEN granted a limited license for IGEN's ECL technology to a newly-created IGEN subsidiary. IGEN then transferred all of its assets (including its rights as licensor under the new license, its rights as licensor under the MSD license and its rights as a member of MSD) to BioVeris, a newly-created publicly traded company unaffiliated with Roche. After the transfer to BioVeris, Roche acquired IGEN, thereby indirectly obtaining the rights in IGEN's ECL technology that Roche wanted.
In connection with the transactions Roche had devised, MST, MSD, Roche, IGEN and BioVeris entered into a Global Consent and Agreement under which the parties consented to the various transactions and granted necessary waivers and consents. Significantly, Section 5.08 of the Global Consent provided that "neither th[e] [Global Consent] 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 . . . ."
In 2007, following a dispute between Roche and BioVeris, Roche acquired BioVeris in a reverse triangular merger. MST and MSD subsequently filed a lawsuit alleging that the reverse triangular merger constituted an assignment of BioVeris's intellectual property by operation of law and that, by failing to obtain the consent of MST and MSD to the transaction, Roche had breached Section 5.08 of the Global Consent. Roche filed a motion to dismiss and argued, among other things, that a reverse triangular merger does not constitute an assignment "by operation of law."
Roche explained that, in a reverse triangular merger, the target survives and its contractual rights and obligations are unchanged; only the target's ownership changes. In this way, according to Roche, a reverse triangular merger is like a change of ownership through a stock acquisition. Roche argued that, accordingly, Delaware case law holding that a stock purchase "does not, in and of itself, constitute an 'assignment' to the acquirer of any contract rights or obligations of the corporation whose stock is sold" should apply by analogy to a reverse triangular merger.
The plaintiffs, on the other hand, contended that a transfer "by operation of law" includes a merger regardless of its form. In support of their argument, the plaintiffs looked to opinions addressing anti-assignment clauses in the context of forward triangular mergers, including one case that suggested that, "[a]s a general matter in the corporate context, the phrase 'assignment by operation of law' [is] commonly understood to include a merger."
The Delaware Chancery Court observed that no Delaware case had considered whether a reverse triangular merger effects an assignment "by operation of law." According to the court, the merger cases that the plaintiffs cited were not controlling because they do not address reverse triangular mergers. Likewise, the court stated that the stock acquisition cases that Roche cited did not control because, though somewhat similar, a stock acquisition is not the same as a reverse triangular merger. The court acknowledged that the stock acquisition cases "exemplify a situation in which a mere change of ownership, without more, does not constitute an assignment as a matter of law." It concluded, however, that, by claiming that Roche took steps after the merger to make BioVeris a mere "shell company," the plaintiffs had alleged more than a mere change in ownership.
Ultimately, the court determined that each of Roche and the plaintiffs had offered a reasonable construction of the term "by operation of law" and that, therefore, the term was ambiguous. Accordingly, the court denied Roche's motion to dismiss, declining to decide as a matter of law that a reverse triangular merger does not result in an assignment "by operation of law" of a contract to which the target is a party.
The Delaware Chancery Court's decision in Meso Scale Diagnostics is an important warning regarding the interpretation of the term "by operation of law" commonly found in anti-assignment clauses. Although the court seems to suggest that a "plain vanilla" reverse triangular merger might not effect an assignment of the target's contracts "by operation of law," practitioners would be wise to seek appropriate consents to avoid a dispute.
A True Test of Liberty
The Delaware Chancery Court considered whether four asset dispositions taking place over seven years and involving a total of 67% of the book value of a corporation's assets together would constitute a disposition of "substantially all" of the corporation's assets. Liberty Media Corp. v. Bank of New York Mellon Trust Co., N.A., No. 5702-VCL, 2011 WL 1632333 (Del. Ch. Apr. 29, 2011). The court concluded that, because the dispositions were the product of discrete business decisions made based on changing circumstances, the four dispositions would not represent a disposition of "substantially all" of the corporation's assets.
Liberty Media Corporation and its wholly-owned subsidiary Liberty Media LLC (collectively, "Liberty") were parties to an indenture under which Liberty issued over $13 billion of debt from 1999 to 2003. The indenture included a successor obligor provision that prohibited Liberty from transferring "all or substantially all" of its assets unless the transferee assumed the obligations under the indenture. After Liberty announced in 2010 that it planned to split off the assets of its Capital Group and Starz Group (the "Capital Splitoff"), Liberty bondholders complained that, when combined with spinoffs in 2004 and 2005 and a splitoff in 2008, the Capital Splitoff would result in a transfer of "substantially all" of Liberty's assets in violation of the successor obligor provision. Thereafter, Liberty filed a lawsuit against the indenture trustee, seeking a declaration that the Capital Splitoff would not result in a transfer of "substantially all" of Liberty's assets.
Liberty split off from AT&T in 2001. At the time of the splitoff, Liberty's assets primarily consisted of small minority interests in large public companies and large minority interests in private companies. Unfortunately, the assets produced little cash flow. To remedy that problem, Liberty implemented a strategy of using its minority interests to acquire control of "mutually supporting operating businesses." When Liberty management determined that it could not reasonably achieve control of a business, however, it pursued alternatives, including spinoff and splitoff transactions that management believed would benefit Liberty's shareholders.
Accordingly, in 2004, Liberty spun off its international cable business, which represented 19 percent of Liberty's book value as of March 31, 2004. In 2005, it spun off its substantial minority interest in the cable channel Discovery, which represented 10 percent of Liberty's book value as of March 31, 2004. In 2009, Liberty split off businesses, including an interest in DirecTV, that represented 23 percent of Liberty's assets as of March 31, 2004. The Capital Splitoff, which Liberty planned to complete by May 2011 and which would leave Liberty obligated under the indenture, represented 15 percent of Liberty's total assets as of March 2004.
Liberty and the indenture trustee agreed that the Capital Splitoff, standing alone, would not represent a sale of "substantially all" of Liberty's assets. The trustee claimed, however, that the previous spinoff and splitoff transactions and the Capital Splitoff should be considered together as part of a single "disaggregation strategy." According to the trustee, when considered together, the transactions would constitute a transfer of "substantially all" of Liberty's assets in violation of the successor obligor provision in the indenture.
The Delaware Chancery Court disagreed. Applying New York law, the governing law for the indenture, the court determined that the Capital Splitoff did not need to be aggregated with the earlier transactions. Consequently, because the trustee agreed that, alone, the assets subject to the Capital Splitoff did not constitute "substantially all" of Liberty's assets, the Capital Splitoff would not violate the successor obligor clause under the indenture.
In reaching its conclusion, the Chancery Court looked to cases that interpreted the meaning of the term "substantially all" as a contract term and cases interpreting the meaning of the term as a matter of corporate law. It noted that "[t]he purposes of the contractual and statutory provisions . . . parallel each other and point toward uniform interpretation" and that courts interpreting New York law in relation to successor obligor provisions had considered cases that construed the term "substantially all" under corporate statutes.
The court evaluated the trustee's claims using the step-transaction doctrine, a doctrine under which separate, but related transactions are treated as a single transaction. According to the court, three tests-the "end result test," the "interdependence test" and the "binding-commitment test"-are applied to determine whether transactions should be aggregated under the step-transaction doctrine. Under the "binding-commitment test" transactions are collapsed "only if, at the time the first step was entered into, there was a binding commitment to undertake the later steps." The "interdependence test" requires transactions to be combined "if 'the steps are so interdependent that the legal relations created by one transaction would have been fruitless without the completion of the series.'" Under the "end result test," multiple transactions are treated as one if they "were pre-arranged parts of a . . . single transaction, cast from the outset to achieve the ultimate result."
The Chancery Court determined that none of the three step-transaction tests were met with respect to Liberty's previous and planned transactions. The "binding commitment test" was not met because none of the spinoffs or splitoffs were contractually connected. The "interdependence test" was not met because each transaction "stood on its own merits" and because the transactions were separated by a number of years.
In applying the "end result test," the court acknowledged that the transactions were part of strategy to obtain controlling positions in operating companies that produced cash. The court concluded, however, that the test was not satisfied because the tactics Liberty used to employ its strategy depended on changing facts and circumstances. Liberty only decided to spin off the international cable business after it "encountered financial and regulatory hurdles." It chose to spin off Discovery and DirecTV only after its efforts to secure control of those businesses failed. The court emphasized that "[f]ollowing a consistent business strategy and deploying signature M & A tactics does not transmogrify seven years of discrete context-specific business decisions into a single transaction." Accordingly, the court decided that the Capital Splitoff would not result in a sale of "substantially all" of Liberty's assets in violation of the indenture.
The Liberty opinion offers important guidance as to when separate asset transactions will be combined for purposes of determining whether "substantially all" of a company's assets have been transferred. In addition, the opinion is a warning that, unless specified otherwise, the term "substantially all" will mean the same thing in a contract as it does in corporate law.
Be Sure to Mean What You Say
The North Carolina Court of Appeals considered whether two parties that had entered into an agreement for the construction and sale of a house were engaged in a joint venture. Lake Colony Constr., Inc. v. Boyd, __ N.C. App. __, 711 S.E.2d 742 (2011). The court concluded that the parties' relationship was a joint venture because their agreement described the relationship as a joint venture, provided for the sharing of profits and required mutual consent as to certain decisions.
Lake Colony Partners ("Partners") and Lake Colony Construction ("Construction") entered into a written contract for the construction and sale of a house in Jackson County, North Carolina. The contract described the relationship between the parties as a "joint venture." Under the contract, Partners was to purchase the lot for the house and arrange for financing and Construction was to act as general contractor, obtain building permits and adequately staff the project. Decisions as to the house plan and lot, major changes in the building plans, and the asking price for the house were subject to the mutual agreement of the parties. The contract further specified that Construction would bill Partners weekly for the actual costs of the project and Partners would reimburse Construction for those costs bi-weekly. Finally, the contract provided that, after liabilities, fees and closing costs were paid, the parties each would receive a payment of a fixed amount and then would share the remainder of the sale proceeds equally.
The house was encumbered by three deeds of trust. After one of the trustees began foreclosure proceedings, Construction filed a declaratory judgment claiming that it had perfected a materialmen's lien with priority over all of the deeds of trust. The trial court determined that Partners and Construction had engaged in a joint venture and that all labor and materials provided by Construction were supplied to further the joint venture. As a result, according to the trial court, Construction's rights were subordinate to the liens under the deeds of trusts. Construction appealed, claiming that the trial court incorrectly determined that the parties' relationship was a joint venture.
The North Carolina Court of Appeals disagreed with Construction and found that a joint venture indeed existed. The court stated that "the essential elements of a joint venture are (1) an agreement to engage in a single business venture with the joint sharing of profits . . ., (2) with each party to the joint venture having a right in some measure to direct the conduct of the other "through a necessary fiduciary relationship." The court easily determined that the first element was met because the parties' agreement provided for the sharing of sales proceeds after the satisfaction of liabilities, the payment of costs and fixed payments to each of the parties. As to the second element, the court observed that it required a finding that Partners and Construction stood "in the relation of principal, as well as agent, as to one another." According to the court, by using the term "joint venture" in their contract, the parties' contract implied that they intended an agency relationship. Moreover, the court noted that the second element does not require that each party control the other party as to all aspects of the project, but only "in some measure." The court decided that, for Partners and Construction, such control existed because some decisions with respect to the project were subject to the mutual approval of the parties.
Lake Colony highlights the fact that how a contract describes the relationship between the parties is important. Although courts will not always give effect to what parties profess their relationship to be, the case is a good reminder to advise clients regarding the legal effect of how they describe their relationships with third parties and to make sure that contracts reflect the relationships the parties intend.
Just Passing Through
The North Carolina Court of Appeals considered the circumstances under which a foreign corporation is required to obtain a certificate of authority to transact business in North Carolina. SongWooYarn Trading Co., Ltd. v. Sox Eleven, Inc., No. COA10-939, 2011 WL 2448513 (N.C. Ct. App. June 21, 2011). The court concluded that a foreign corporation whose business operations are located outside North Carolina is not transacting business such that a certificate of authority is required when the corporation enters into contracts with a North Carolina corporation that are "dependent on acceptance" outside of North Carolina and involve the shipment of goods to a location outside North Carolina.
SongWooYarn Trading Company, Ltd., a South Korean company based in Seoul, South Korea, sells socks and other spun yarns to wholesalers and distributors. Sox Eleven, Inc., a North Carolina corporation with its daily operations in Charlotte, facilitated SongWooYarn's sales in the United States. In 2007, Jae Cheol Song was the majority owner of both SongWooYarn and Sox Eleven.
Among SongWooYarn's customers in the United States was Crescent Hosiery, a Tennessee wholesaler. When Crescent wished to purchase socks from SongWooYarn, it sent purchase orders to Sox Eleven. Sox Eleven forwarded the purchase orders to SongWooYarn, and SongWooYarn shipped the socks directly to Crescent. SongWooYarn billed Sox Eleven for shipments, and Sox Eleven in turn billed Crescent. After receiving payments from Crescent, Sox Eleven deducted taxes and shipping charges and sent the balance to SongWooYarn.
SongWooYarn filed a lawsuit against Sox Eleven's manager after SongWooYarn failed to receive payment in full from Sox Eleven for a 2007 shipment to Crescent. The manager claimed that SongWooYarn did not have standing to file the lawsuit because it had been transacting business in North Carolina without a certificate of authority. The North Carolina Court of Appeals disagreed and determined that SongWooYarn was not transacting business in North Carolina and therefore did not need a certificate of authority to file a lawsuit. The court noted that, although SongWooYarn entered into contracts with Sox Eleven for the sale of socks, the contracts were dependent on acceptance in Tennessee by Crescent. Based on this fact, the court concluded that N.C. Gen. Stat. §§ 55-15-01(b)(5) and 55-15-01(b)(8) applied, which provide that a foreign corporation is not transacting business in North Carolina by reason of "[s]oliciting or procuring orders . . . where such orders required acceptance without [North Carolina] before becoming binding contracts" or by reason of "[t]ransacting business in interstate commerce."
SongWooYarn provides valuable guidance as to when a foreign corporation is engaging in activities in North Carolina such that it needs to obtain a certificate of authority. •
Thomas Molony is assistant professor of law at Elon University School of Law.
Views and opinions expressed in articles published herein are the authors' only and are not to be attributed to this newsletter, the section, or the NCBA unless expressly stated. Authors are responsible for the accuracy of all citations and quotations.