May 22nd, 2014

Including a “Change of Control” Clause in Business Contracts

You’ve searched for the right business partner and have finally found the one you think will be right. You are prepared to promise a term of 6 years with 2 optional renewal periods of 1 year each. What could go wrong? For one thing, the people who run or own the business can change. Even after diligently researching and evaluating the party to which you are obligating your business by contract, you may risk having to deal with another party in the future. The “counter-party,” may transfer all or some of its assets or stock in the business to a third-party, leaving you to deal with a new partner, who you don’t know, or who might potentially even be a competitor of yours. What can you do?

Many contracts contain an anti-assignment clause, which prohibits the parties from assigning their rights or obligations under the contract to another party. In addition, contracts should, but often do not, have a “Change of Control” clause, allowing you to have recourse (even termination) if the partner that you’re doing business with changes in ownership or structure. In the case of an asset sale by that party, for example, you might not want to be doing business with a shell of a company that has sold a dramatic portion of its assets or those parts of its business that are most important to you. Having the right to terminate the contract in the event of a sale of particular assets, a particular percentage of assets, or a particular line of business, protects your interests. Stock sales, which can occur without your knowledge, can result in ownership of the business being altered dramatically; the transfer of the business could even be made to one of your competitors. It’s important for you to know of such proposed transactions in advance and take steps to protect your business.

For this reason, among others, contract drafters will include a Change-of-Control provision which allows a party to determine if and how he would like to continue to do business in the event of a change of ownership, change of management, or change in the assets of the other party. This can stand alone or be a part of the assignability section. When drafting a Change of Control provision, make sure you:

  1. Address assignability.
  1. Define the kind of change that you fear the most.  Is it the transfer by a counter-party of a certain percentage of ownership or interest? The sale of “all or substantially all of the assets” of the counter-party? Maybe a change in the make-up of the governing board?  This is a good time to examine and define the affiliates of your counter-party. Depending on how much ownership they have in common with the original party to the agreement, changes of control involving affiliates may not affect operations significantly.
  1. Determine the type of control you require.  Should you require your counter-party to obtain your consent? Provide payment? Give you the right to terminate the contract if you decide you do not want to do business with the third-party.

For more information about particular contract clauses that help you protect your business interests, contact us today.

About the authors:

Attorney Paul McGinley practices business and commercial law, counseling small and large business clients in a variety of industries.

Attorney Nicole O’Hara regularly negotiates contracts for the commercialization of intellectual property and other business agreements.