Beware of Contract Assignments and Change of Control Provisions

CEO discussing financial strategy with partner

Hispanic business owners should watch out for Assignment and Change of Control Provisions.

Why? Because they can radically change how you handle business.

Let’s look at a scenario:

Carlos has developed a very successful Software company—Let’s call it “My Favorite Software Company,” or “MFSC” – with a score of clients with whom he has been working for years. One day, Carlos was approached by a representative of Big Software Inc., one of the world’s largest software companies. Big Software was interested in purchasing Carlos’s company for a generous sum. Carlos and his family were naturally very excited, dreaming of villas on the Spanish coast. 

As part of the acquisition process, Carlos was asked by Big Software to review MFSC’s customer contracts, as the bulk of MFSC’s value naturally related to the customers the company serviced.  It had been a long time since Carlos even took a look at his customer contracts. In fact, Carlos never actually reviewed the contracts to begin with, assuming that the form contract he had been given by an attorney-friend of his had all the appropriate clauses.

In any case, upon reviewing MFSC’s customer contracts, Carlos came across two  provisions in each contract, which puzzled him.

This is what they said:

Provision 1:

“The Customer may terminate this Agreement and/or any all Statements of Work at any time by giving written notice to provider in the event of a change of control of provider.”

Provision 2:

“Provider shall not assign any rights or delegate or subcontract any of its duties without the prior written consent of the customer which may be withheld at its discretion.”

Carlos retained a trusted attorney Steve Rivers who provided the following advice:

Although the term “change of control” was not specifically defined in the agreement, it generally means a shift in majority control to a third party. Steve explained that, were Big Software to purchase MFSC, a good argument could be made that the purchase would trigger the Change of Control provision of each contract, affording the customer the right to terminate the Customer Agreement.

Regarding the assignment provision, Steve similarly explained that if (as part of Big Software’s purchase) a customer contract needed to be assigned, then the customer had to provide its consent.

In other words, because of the change of control provision and assignment provision in each customer contract, MFSC needed at some point to notify its customers concerning its prospective sale to Big Software and then take stock of which customers consented to the prospective change of control and assignment. Generally, this process would involve a detailed discussion with the prospective purchaser about the need to contact customers, and a discussion about how customers would be approached and the procedure necessary to obtain each customer’s written consent. 

Many companies actually undertake marketing campaigns designed to explain to customers how their services may be enhanced as the result of becoming part of a bigger organization with more resources.

At the end  of the day, customers who have built their infrastructures around a particular service provider are likely to consent to a change of control/assignment as long as they are assured  that their service will not be impacted, and this  issue is one that should be brought to the attention of Big Software as a negotiating point.

It should be noted that the situation confronted by Carlos is common, because sometimes, depending on the customer, obtaining more favorable language is simply not possible. However, at least in its initial presentation of its contract to a customer, a  service provider company should  try to avoid change of control provisions and  carve out of assignment prohibitions  the right to assign contracts in the event of a  merger, sale of assets, or reorganization. An example of the type of language proposed is as  follows:

“A party is prohibited from assigning its right or duties without the written consent of the other party, provided that consent is not required if the assignment is pursuant to a merger, acquisition, reorganization, or change of control involving the assignor.”  

At the end of the day, Carlos still may be able to purchase his villa in Spain, but he is going to have to work to preserve his customer assets, and this could take time and money. 

The Takeaway:

Service providers should review their model contracts with an attorney to make sure that all the contract provisions are appropriate to the situation. For example, a company, with a five-year plan to flip to a third party, should try to make sure that, when the time comes to transfer assets, the transfer is not encumbered by challenging assignment or change of control provisions. 

Related Articles:

How to Address the Costs of Legal Services for Your Business

Cuban American Latina Attorney Promotes Diversity In the Legal Profession

When Is an Oral Contract a Legally Binding Agreement?

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