By Ben Hicks
A few weeks ago, we began a new blog series titled “Know Your Boilerplate,” where we outline what is commonly known as “the boilerplate” in contracts. In the business world, contracts provide the framework for the daily relationships necessary for a business to operate — with vendors, employees, contractors, service providers, and strategic partners — as well as transformational events in the life of a business such as the purchase or sale of real estate, equipment, other assets, or the business itself.
Too often, business owners focus solely on the high-level business terms in a contract that structure the overall business relationship between the parties. In a perfect world, training one’s sights on these parts of a contract would be fine, but in the real world, transactions and relationships inevitably sour from time to time. When the high-level business terms in a contract come into question, it is the boilerplate that determines how well or poorly positioned a business is to defend its interests.
In our last installment, we looked at notice provisions which govern timeframes and methods for making changes to or ending a contractual agreement. Today, we are discussing anti-assignment and change of control provisions.
When parties hash out the terms of a contract, they typically have some basic level of familiarity with the counterparty and are focusing on what it will look like for each party to have an active business relationship with the other party or parties for the duration of that contract. An assignment provision, however, provides a mechanism by which the identity of one party to a contract may change. The basic legal principle is that contracts can be freely assigned, unless otherwise prohibited by law, by public policy, or, most importantly for purposes of this article, by the terms of the contract itself.
While contract law may provide that contracts, absent special circumstances, are freely assignable, contracts frequently include a provision that a party cannot assign the contract without the approval of the other party or parties to the contract, known by attorneys as an anti-assignment provision. This concept makes sense, given that the contract is intended to document a specific business relationship with a specific counterparty. If a business owner or its counsel is not careful in reviewing the boilerplate provisions of a contract, however, he or she might not notice that an anti-assignment provision is missing and may incorrectly assume that a contract is not assignable when, in reality, it is. While the implications of this are obvious, they merit emphasizing – a party may have allocated time, effort, and legal budget to build and document a business relationship, only to later be forced to enter a new business relationship with a potentially unknown third party for reasons outside of its control without the ability to exit that relationship. Parties should thus be careful to consider whether an anti-assignment provision is in fact included in an agreement.
The cousin of the anti-assignment provision is the change of control provision, which provides that certain corporate transactions, such as a change in equity ownership of a business or the sale of substantially all of the assets of a business, either are or are not deemed to be an assignment requiring the consent of the counterparty or giving rise to certain other rights of the counterparty, such as the right to a mandatory penalty payment or a right to terminate the contract altogether upon receipt of the request for consent.
Businesses should carefully consider whether they should require the inclusion of a change of control provision in their contracts that permits a change of control transaction without requiring the consent of the counterparty, because failure to do so could complicate or even jeopardize future M&A opportunities. If a business has significant contracts that include change of control provisions requiring counterparty consent, and the counterparties are unwilling to consent to an M&A transaction involving that business, the owners of the business may be forced to incur significant expense, both in terms of legal expense and in terms of adverse valuation of the business, in structuring a transaction that does not trigger the consent requirement of the applicable contract.
Extensive case law exists concerning the interpretation of anti-assignment and change of control provisions, specifically regarding whether a prohibition of a particular type of M&A transaction is implied by the terms of a particular provision, and the results of such case law have been unpredictable. Parties would almost always have been better served by addressing the issue explicitly in a contract rather than by relying on a boilerplate provision without discussion or negotiation and forcing a court to determine the parties’ intent after a dispute has arisen.
As with other boilerplate provisions, business owners always need to review their contracts for assignment and change of control provisions with different scenarios and end games in mind. A failure to do so, or a willingness to accept a counterparty’s boilerplate without thorough review out of a desire for efficiency, may have significant adverse effects both on the relationship itself and on potential M&A opportunities. I have committed much of my practice through the years to drafting, negotiating, and reviewing all elements of contracts. I have extensive experience assisting both buyers and sellers in M&A transaction perform due diligence, and I frequently see boilerplate provisions, especially assignment and change of control provisions, add unnecessary complexity and inefficiency to transactions because businesses and their counsel have failed to properly vet key contracts. Contact me at the Forrest Firm if you are interested to hear more about how I can help you draft or review your business’s contracts.
In our next installment in this series, we will discuss governing law and jurisdiction clauses.