This article has been written by Shivam Sharma pursuing the Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho. This article has been edited by Anahita Arya (Associate, Lawsikho) and Dipshi Swara (Senior Associate, Lawsikho).
Both assignment clauses and change of control clauses are Boilerplate Clauses, i.e., clauses which are deemed to be standard, miscellaneous and of general nature. Like most Boilerplate Clauses, these are tucked away at the back end of the agreements and can seem to be generic and dry. But for most technology companies, a wrong assignment or change of control clause could drastically affect the valuation of their company. This is especially true for contracts concerning intellectual properties.
In a nutshell, the Assignment Clause dictates whether or not one of the parties to the contract can transfer the contract to someone else who is not a party to the contract. If the contract can be transferred, then the assignment clause also dictates when such a transfer will take effect. This usually takes place when there is a change in control in the management itself, for instance, in the case of a merger. Yet, that doesn’t make it into a change of control clause.
The Change of Control clauses themselves does not address assignment. Such a clause states whether a party can terminate the contract if the other party goes into a merger or there is a change in control via other means. In addition, they can also address what are the consequences of such a change in control.
Being boilerplate clauses, these two clauses are often neglected and not always clearly labelled (and in some instances even mislabelled). Yet as this article will show, they are indispensable for the valuation of a tech start-up. This article attempts to showcase how these two clauses operate in a contract and how they differ in meaning and interpretation.
Why are these clauses important for tech-driven companies?
Most budding tech enterprises tend to be risk-taking ventures, which end up losing a lot of cash in short spans of time. In order for them to survive it becomes imperative that they adapt to and make the best of corporate opportunities. These include opportunities for mergers, acquisitions, joint ventures etc. Yet with all these transactions, the prerequisite is for the company to have a very strong market valuation.
This valuation is further dependent upon the products it has developed. For a technology company, this value comes down to two main factors:
- The intellectual property (IP) it owns;
- All the contracts that affect the development of the above-stated IP, such as research and development agreement, Intellectual Property licenses, consultancies agreements, etc.
If the contracts which affect the development of the IP do not survive the M&A transaction, they have no value to the acquirer. As the intellectual property itself is central to the tech company, an IP contract with no value would connote no value of the tech company itself. Thus in every M&A transaction, it is the valuation of the IP that matters the most. This valuation is further subjected to close scrutiny of the ‘Assignment Clause’ and ‘Change of Control Clause’.
Sale of business of a tech-company
There are two ways in which a business can be sold, via the sale of shares of the company (sale of controlling power) or via the sale of assets of the company. When the assets of the company are being sold, the party’s IP contracts get transferred to the buyer. This is a situation where the assignment clause steps in. An assignment clause dictates whether a party holds the right to assign or novate the contract to a third party. If the assignment clause allows for the transfer, it will add to the value of the tech company in the evaluation by the acquirer. A change of control clause, on the other hand, comes into play when there is a change in managerial control of the party. This occurs when the entire business of the party is being acquired by a third party. Generally, a change in control clause will state that in case a party undergoes a change, the other party shall have a right to terminate the contract. This is why this clause is also called the “poison pill” in the event of acquisition of a party. This is because, post the acquisition, the agreement itself has no value to the acquirer.
Generally, there is not an outright ban on assignment under the agreements. The agreement may state that the assignment is possible as long as there is a written consent provided by the party to the other party.
Sample Clause: The parties agree to the following:
- That none of the parties to this Agreement shall assign any of its rights or obligations or the entirety of this Agreement to any third party without the written consent of the other party;
- That the above clause shall not apply in the case of one of the parties undergoing a merger or acquisition of the entire entity or of substantially all its assets;
- That the above two clauses shall be binding upon the respective successors and assigns of the parties to the Agreement.
From the above sample assignment clause, it can be inferred that there cannot be any assignment except for in the case of merger and acquisition. Thus, an assignment clause answers the following questions:
- Can there be an assignment to the Surviving Entity in the cases of merger and acquisition? The Surviving Entity can be both a new company or another company that took over the original party to the contract. Assignments are especially tricky when the original party to the agreement is no longer in existence as now the agreement will be carried out by a completely different party.
- Can the party (being a company), assign the contract to its affiliates, i.e., its parent company, its sister companies, its subsidiaries, etc.? This is much easier to negotiate as the affiliate companies are already in existence and there is an absence of the element of surprise as in the case of a merger and acquisition.
- Can there be an assignment made to Divested Entities? This is especially of grave importance to technology companies.
- In case a party finds itself at a point that it cannot competently discharge its obligations, can it assign the contract to its competitors? If yes, then what would the term ‘competitor’ connote?
Change of control clause
A change of control clause constitutes of two main elements:
- The definition of change in control;
- The operation of the clause after the occurrence of an event that meets the requirement under the definition.
There exists no standard definition of change of control but it does include the following transactions:
- A transfer of shares of the company;
- A complete sale of all or a substantial portion of assets of the company;
- Mergers and Acquisitions.
Sample Clause: The parties agree to the following:
- That if either party undergoes a change of control, the other party shall have the right to terminate the Agreement within a period of 30 days from the date of change of control;
- That for termination of Agreement under the above clause, the party terminating the contract must serve a 30-day notice on the other party;
- That the term ‘change of control’ shall mean any transaction or a series of transactions whereby more than 50 per cent of the outstanding shares of the target company is acquired within a duration of one year.
From the above-stated sample clause, it becomes clear that a party will have the right to terminate the agreement in the event that the controlling ownership of the other party changes hands.
Followings are some of the uses of a Change of Control Clause:
- In the event of a smaller change in ownership: In the example above the change of control was held out to be 50 per cent or more. This, however, could be a bar set too high for some and thus even a lower standard can be prescribed, such as such a change of ownership of shares representing 25 per cent of the total outstanding shares. This is especially helpful when the company in question is a public company where control can change hands with a change as small as 10 per cent.
- When will there be no right to terminate the agreement? This can include events where the shares held in irrelevant quantities exchange hands.
- Should there be a payment made to the party when there is a novation? If the amount of payment to be made is huge it can affect the valuation of the party.
Summary of differences
The table below is a summarized representation of the differences explained above:
|Assignment Clause||Change of Control Clause|
|It addresses the question as to what happens when a party to the contract undergoes an M&A deal and is no longer in existence or has become a shell company.||It addresses a situation where the party which has undergone the M&A transaction is still in existence.|
|The company is selling its assets (Intellectual Property).||There is a change in the managerial control of the party, i.e., the entire business of the party is being acquired by a third party.|
|Generally, assignments will be allowed in a contract unless there is an anti-assignment clause present.||Generally, a change in control clause will state that in case a party undergoes a change, the other party shall have a right to terminate the contract.|
|If the assignment clause allows for the transfer, it will add to the value of tech company in the valuation by the acquirer.||This clause is also called the “poison pill” in the event of acquisition of a party. This is because, post the acquisition, the agreements in relation to IPs will have no value to the acquirer. As such, this clause causes the valuation to decrease.|
|Usually, there is a requirement of novation in order to facilitate a valid assignment.||Once there is a change of control, it will lead to the termination of the contract. There will be a new round of negotiations and new contracts will be entered into.|
Both Assignment Clause and Change of Control Clause address two very different kinds of changes. When an assignment clause addresses a change in control, it addresses the question as to what happens when a party undergoes an M&A deal and it is no longer in existence or has become a shell company. On the other hand, a change of control clause addresses the situation when the party which has undergone the M&A transaction is still in existence.
It is usually the practice to leave the discussions on the boilerplate clause to the very end of the negotiation stages. However, as this article attempted to show, ‘Assignment Clause’ and ‘Change of Control’ clauses are by no measure generic and are in reality quite essential to the valuation of young tech-start-ups. Thus, it is required that more concentrated efforts are poured into the negotiation and drafting of these two clauses so as to reach a point of seemingly innocuous boilerplate provisions.
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