Why and How to Include a Change of Control Clause in Contracts
Risk & Compliance
Contracts are inherently risky, and a number of things can go wrong that may result in a costly contract dispute. Of course, there may be a change in circumstances that is not even addressed in a contract, and thus contesting any such unwanted change is not even a possibility, or perhaps there is only a remote chance of success in the courtroom. One rather significant change that is quite likely to occur and yet not often addressed in contracts is a change in the structure or ownership of one of the parties to the contract. Companies are bought, sold, and merged all of the time, but contracts are often silent as to the impact that such a change should or will have on the existing contract. This is obviously a mistake as a change in ownership may cause changes, both intentional or inadvertent, to the established arrangement. For example, a newly formed entity may change vendors or subcontract with new parties, situations in which the nature, quality, or timing of contractual obligations is altered.
But, this potential scenario is easily avoided by simply including a provision in a contract that explicitly details how the contract must be treated in the event of a change in control. For example, a company may wish to render the contract void if the other party to the deal undergoes a change in ownership. This may be an extreme choice, but there has to be predetermined options clearly written into the agreement. Here is how to include a change of control clause in business contracts:
Identify Problematic Changes
The first step is to identify the types of changes that your company may consider problematic to a contract as it stands. For some companies, a change in ownership may not be a big deal. However, in some instances, the contract may be very specific or address a unique product or service, and thus it may be difficult to replicate the terms with a new entity. Of course, some companies simply may not want to deal with the hassle of getting to know new leaders if one of its contracting partners is acquired or take the risk that the new management will not be a good fit. Ultimately, when a company enters into a contract with another firm, it must determine the circumstances under which it would not want to continue the contract as originally negotiated and drafted.
Differentiate Between an Assignment and Change of Control
A lot of contracts forbid an assignment, which prevents one or both parties from assigning its rights and obligations under the contract to a new party. This may seem like it covers a change of control, but it does not as an assignment is a specific action taken. A change in control clause must specifically address how the contract is to be handled if or when the other party to the agreement undergoes a specific type of change to its structure and/or ownership. A robust contract will include distinct yet detailed clauses with respect to both assignments and changes of control.
It is always possible that the change of control issue will not even come to fruition. Thus, rather than get bogged down in trying to avoid this situation, it may be possible to negotiate some requirements in the event that it does in fact occur. For example, your company may seek to include some kind of permission process during which the other side seeks consent to make the change and maintain the contract or provide some form of payment as compensation for the change. Obviously, retaining the right to terminate the contract affords the most protection, but whether this is needed really depends on the type of agreement at stake.
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