North Valley Mall v. Longs Drug Store – Cal. Ct. App. holds that reverse triangular merger did not violate anti-assignment provisions

The following is a case update prepared by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, analyzing a recent decision of interest:

SUMMARY:

A California appellate court has held that a reverse triangular merger did not violate an anti-assignment provision in a lease because the original corporate tenant still nominally retained the leasehold, even though control over the property had passed to the original tenant’s new parent corporation. [North Valley Mall, LLC vs. Longs Drug Store S California, LLC, 2018 Westlaw 4579856 (Cal.App.).]

FACTS: A landlord and a corporate tenant entered into a commercial lease and related agreements. The agreements provided that as long as the original tenant held the lease, the annual “common area maintenance” (CAM) charges would be capped at a quarter of one percent of the tenant’s gross revenue. However, if the lease were ever transferred to a third party, that cap would no longer be in force.

Forty years later, the corporate tenant was the target of a “reverse triangular merger,” under which the acquiring entity formed a subsidiary. The new subsidiary then merged with the target entity, the corporate tenant. At the end of the transaction, the target entity became the wholly owned subsidiary of the parent entity, the acquiring corporation. The leasehold was still nominally held by the corporate tenant, even though the new parent entity was in control of the corporate tenant.

The landlord’s successor filed suit, claiming that the reverse triangular merger was a de facto assignment of the leasehold to a new entity, thus terminating the contractual cap on the CAM fees. The trial court granted summary judgment in favor of the corporate tenant, and the appellate court affirmed.REASONING: On appeal, the landlord argued that a de facto merger had occurred, terminating the cap on the CAM charges:

[The landlord] points to the fact that the [tenant’s] headquarters was moved to [the parent entity’s] headquarters, all [of the tenant’s] executives and employees in the headquarters office were let go or resigned, [the tenant] became a limited liability company, the sign on the property was changed from [the tenant’s name] to [the parent’s name], [the parent’s] products are now sold at the property, and the store on the property now possesses an alcoholic beverage license in issued to [the parent entity].

The court held, however, that the language of the original agreement prohibiting transfers to third parties did not encompass the “reverse triangular merger” scenario:

The . . . Agreement indicates that the parties intended the CAM cap to be lifted if the corporate real property was sold or leased. We cannot interpret this language to include a sale of corporate stock. [The landlord] asks us to conclude that even if the property at issue was never sold or leased by [the tenant], we should look behind the reverse triangular merger and conclude that it was a de facto merger, resulting in the transfer of the property to [the parent]. We decline to do so.

The court later noted that there was no equitable reason to recharacterize the merger as a transfer of the assets: “The reverse triangular merger was not performed for an improper purpose, and we are aware of no authority that would support finding a property transfer where there is none.”

Finally, the court declined to reach the tax ramifications of the transaction, noting that even if the transfer of control might be sufficient under state law to trigger a change in the property taxes, that did not determine the outcome of the court’s interpretation of the parties’ agreements.

AUTHOR’S COMMENT: Although there is some conflict in the authority, this case represents the majority view: a reverse triangular merger does not necessarily violate a “change in control” or “anti-assignment” clause. However, the result really depends on the wording of the clause itself. A broadly drafted clause that specifically includes reverse triangular mergers as impermissible transactions should be enforceable.

These materials were written by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, for his Commercial Finance Newsletter, published weekly on Westlaw. Westlaw holds the copyright on these materials and has permitted the Insolvency Law Committee to reprint them.