Monday, April 11, 2011

Assignment, Novation, Change of Control, Pledging

In business today change occurs frequently. Buyers may divest certain business that previously had contracts with a Supplier. Suppliers may want divest certain operations or businesses that had contracts to sell products or services to Buyer. A party may want to assign some or all of their rights or liabilities to third parties.
As these situations may arise during the term of the contract you need to be prepared to deal with them in your contract negotiation.

It’s important to understand the concepts of each.

An Assignment is the act of transferring an interest in property or some right (such as contract benefits) to another. Under an assignment the party that assigned the agreement would be secondarily liable to the original party unless the parties otherwise agree.
For example if A and B have a contract and B assigns that contract to C,  C would be primarily liable to A and B would be secondarily liable to A if C did not meet the obligations of the contract,

A Novation is agreement of parties usually done in conjunction with an assignment where upon the assignment there is now a new agreement between the original party whose contract was assigned and the party to whom the contract was assigned that in effect extinguishes (cancels) the old agreement and relieves the assigning party of liability under the contract.  
For example if A and B have a contract and there is an assignment and novation of that contract by B to C, the contract would now be between A and C and B would no longer be liable to A under the contract as the “novation” extinguishes their liability

A “change of control” occurs when the entire company is sold to another company or merges with another company where the original company does not have controlling interest in the combined company.
            For example B is sold in its entirety to C. or
B Merges with C and B does not have majority control over the merged entity.

Pledging is when a company (usually the Supplier) wants to assign its right to payables to a third party (usually a financial institution)
            For example B the Supplier may seek to have all payables by A the Buyer
Be assigned to C (Supplier’s Bank) as part of a revolving line of credit C has with C.

The risks with an assignment is that instead of dealing with the party that you contracted with, you are now dealing with another party so there could be a loss in value, increase in problems etc. So from a Buyer’s perspective you want to prevent the Supplier from being able to assign the contract without your consent.
The typical things that get negotiated in Buyer’s consent to the Supplier doing an assignment is whether consent is solely at Buyer’s discretion or is subject to a reasonableness standard.  Most Buyers would prefer to be able to assign their contract without requiring the Supplier’s consent as they see needing to get the Supplier’s consent as an opportunity to “hold them up” where they would use Buyer’s need for the consent to leverage something better for them such as an additional payment of fee. So Buyers will pursue the unilateral right to assign in certain business situations such as the sale of the business that uses the contract.

The risk with an assignment and novation is for a Buyer to agree, it is just like qualifying a new supplier where you need to determine whether the new company has the necessary assets and resources to stand behind not just future commitments but also to stand behind all of the potential liabilities with respect to prior sales such as the warranties, indemnities, etc. Most of the time Suppliers that are involved in these types of assignments want it to be an assignment and novation so they have no liability going forward and Buyer can only look to the new entity.  That may be fine if the new entity has everything you need or what to ensure you remain protected, but what if they don’t? One option is to refuse to agree to with the novation. I’ve encountered Suppliers that simply refuse to accept anything but an assignment and novation. When I refused, the contract remained with them to perform. But that was clumsy. So I also did a new agreement with the new entity that simply incorporated by reference all the terms of the existing agreement so going forward they would sell at the same terms and pricing as the original supplier. While that would mean that on purchases going forward you would not be able to look to the original Supplier for liability, what it did do was to keep the original supplier still liable for all their prior sales and any liability associated with them.

The risk with a Change of Control is the potential negative impact a change of control might have (such as the supplier being sold to a major competitor of your company’s). Most companies would never give a Buyer veto power over who that may potentially sell their company to or merge with, but from a Buyer’s perspective if the change of control is problematic to the Buyer the Buyer should have the right to terminate the agreement in the event of a change in control.

The risk with pledging is you are introducing a third party to the relationship whose sole concern is the payment of monies to them. So if you are going to agree to pledging, the language would need to make sure that activity has no impact on the Buyer’s rights or remedies.

Let’s take a look at sample terms for each

Assignment language usually contains several sections
  1. The prohibition
“Neither party will assign their rights or delegate or subcontract their duties under this Agreement to third parties or affiliates without the prior written consent of the other party
  1. the standard for the consent
    1. “such consent not to be withheld unreasonably”
    2. “such consent shall be in Buyer’s sole discretion”
  2. The impact of an un-authorized assignment
    1. Any unauthorized assignment of this Agreement is void.”
  3. The rights of the parties to assign the agreement in conjunction with the sale of the Business providing or using the Contract goods or services.
    1. except that Buyer may assign this Agreement in conjunction with the sale of a substantial part of the business utilizing this Agreement
  4. Any restrictions on the agreed assignment
    1. “To a non-competitor of Supplier.”
    2. “provided such company has a substantially similar financial position as supplier”


If you wanted to prevent a novation you might include something like the following:
“This contract shall be binding on the parties and their respective successors and permitted assigns. Except in the instance of an assignment or transfer by Buyer of all or any portion of this agreement, the assigning party shall remain liable for the performance of any assigned or transferred obligations hereunder.
The requirements for a novation may vary by jurisdiction. For example in New York for there to be a novation it must specifically say it is a novation. In assignment consent letters Suppliers may try to create a novation by the words they use where the language in affect would say that Buyer may only look to the new entity going forward.

Change of Control

A change of control is different that an assignment as the contract is not being moved to a different company, and in fact the original supplier may continue to operate as a independent legal entity that is simply owned by a third party. If they wanted to move the agreement from the original supplier company to a different affiliate company, which would be an assignment and the terms of the assignment provision would apply,

Should you be concerned about Change of Control and have contract language to deal with that?  In some cases you should. For example, if your competitor purchases a key Supplier of yours it may be harmful. The problem is that it is impossible to negotiate change of control clauses in an agreement that would prohibit the sale of their business. That’s because company’s officers and directors have a fiduciary obligation to act in the best interests of their shareholders so they would not be willing to agree to anything that restricts their ability to have their company merge with or be acquired by another company. At best what you may be able to negotiate into the agreement would be terms that give you certain rights and remedies should there be a change of control that could be damaging to you. For example you could potentially negotiate in a term where if there was a change of control and the new entity was in direct competition with you, you would have certain rights such as the right to terminate the agreement with reduced or no liability within a certain period of time to allow you to move to another entity if possible. For example:

“In the event of a change in Control of Supplier, where all or substantially all of the assets of Supplier are acquired by any Entity, or Supplier is merged with or into another Entity to form a new Entity (a “Change of Control”, then at any time within twelve (12) months after the Change of Control occurs, Buyer may, terminate this Agreement, in whole or in part, with sixty (60) days written notice. Buyer’s sole liability in the event of such termination shall be _________________ [

If you were to agree with the concept of allowing the Supplier to pledge or assign their rights in accounts receivables to a third party, there are a number of protections that you would need to put in place for that so Buyer’s rights are unaffected  The following is an example of a clause that you add.
“Supplier may assign Supplier’s right to receive payments under this Contract; provided, however, that any such assignment (a) will not increase the number of payments or amounts due from Buyer, (b) will be subject to any claims and offset rights as well as Buyer’s right to receive payment for unused credits, and (c) will not affect any of Buyer’s rights or remedies under this Agreement.  If Supplier assigns any of its rights to receive payments hereunder, then Supplier agrees to indemnify, defend and hold Buyer harmless from any and all claims, damages or losses relating to claims brought by any non-party asserting rights under this Agreement.”

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