IN THIS LESSON
Check that material contracts can be transferred to the buyer as part of the proposed transaction.
Introduction
The material contracts are an important part of a target’s business and generally comprise two categories:
customer contract (selling goods and/or services)
supplier/vendor contract (buying goods and/or services)
As such, the Buyer will generally want to transfer these contracts to itself or ensure they will be acquired as part of the transaction without a penalty (e.g. termination).
As a general rule, if the transaction is structured as an Asset Sale (buying the assets/business only), then review the assignment clause. Whereas, if the transaction structure is a Share Sale (buying a company’s shares) then review the change of control clause.
Buying the assets or business only (Asset Sale)
For an Asset Sale, you will need to review the assignment clause because an Asset Sale generally involves assigning the contracts. The most common types of restrictions on assigning a contract include:
Cannot occur: An assignment is strictly prohibited under the contract
Consent: The consent of the counterparty to the assignment is required
Other conditions: Certain other conditions need to be satisfied before the contract can be assigned (not including consent or notice conditions such as the assignee meets certain financial or technical requirements)
Notice: The counterparty must be notified that the contract will be assigned
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Buying a company’s shares (Share Sale)
For a Share Sale, you will need to review the change of control clause to see if there is a restriction or prohibition on there being a change of control of the target company under the contract.
What does change of control mean?
First, you need to consider when does the contract deem there to be a change of control of the target company. There is no fixed meaning of change of control, so you will need to review the contract. Change of control commonly means one or more of the following:
a party to the contract is acquired so there is a change in who owns the shares of that party
A party to the contract sells all or a majority of its assets
A party undergoes a merger
A party undergoes a change in management
A party undergoes a change in the board of directors
Then, review the change of control clause to see if there is a restriction or prohibition on there being a change of control of the target company.
What is the change of control restriction?
The most common ones include:
Cannot occur: A change of control in a party is strictly prohibited under the contract.
Consent: The consent of the counterparty to the change of control is required before the change of control can occur.
Other conditions: Certain other conditions need to be satisfied before a change of control can validly occur (not including consent or notice conditions).
Notice: Notice of the change of control must be given to the other party.
Even if there is no change of control clause, check whether the assignment clause applies to a change of control. If that is the case, then the provisions in the assignment clause will need to be considered.
Will the clause be triggered by the proposed transaction?
You will need to consider whether the proposed transaction will trigger the operation of the assignment or change of control restriction and therefore the provision must be complied with to avoid being in breach of the contract (or the contract being terminated). The below course of action is recommended.
Yes, it is triggered — Action required — see next section
No, it is not triggered — No action required
Unsure whether it is triggered — Ask your supervisor
Required action if restriction is triggered
It is common for the counterparty’s consent to the assignment or change of control be obtain before the contract is assigned or there is a change of control. Consider raising this restriction as a “red flag” in your due diligence so your client can act on this and obtain counterparty consent sooner rather than later, particularly if it is a material contract.
What are the consequences of the clause being triggered?
In commercial contracts, a change of control clause often gives the counterparty the right to terminate the contract in the event of a change of control, but there may be an opportunity to demonstrate to the counterparty’s reasonable satisfaction that the company will continue to be able to meet its obligations under the contract, even after a change of control.
Your client will need to consider the risk of contract termination and what impact that will have on the value of the target company or asset they are buying if the contract is terminated.