Thursday, June 21, 2012

Assignment versus Change of Control

What is the difference between Assignment and Change or Control provision? That was a question someone asked in another forum and I thought I would share and expand upon my response.

Contractually you are able to prevent assignment of the contract to another party. You do this because you were confident in that other party and were relying upon that other party for performance. You don’t want to be dealing with someone else unless you approve.

As Directors and Executives of companies have the fiduciary responsibility to do what is best for their shareholders, they would never agree that they cannot merge with or be acquired by another company as that would violate their fiduciary responsibility. Since you can’t restrict those activities from occurring, you use the change of control provision to protect your company when those change of control situations occur.

A change of control provision normally includes a right for the other party to terminate the agreement without liability within a specific period after the change of control. A good example of why you would want a change of control provision would be if a competitor acquires one of your suppliers and you no longer want to do business with the supplier as a result because of competitive concerns. The change of control provision should allow you to terminate the agreement without liability for the termination. It should be without liability, as the party who merges with another knows that this is a risk they have if they agree to a merger and a merger is a voluntary thing they can control. If there is an acquisition, as part of the due diligence the acquiring company knows that this is a risk where you could walk away without liability.

In negotiating a change of control provision you want the period you have to be long enough for you to develop and implement an alternative strategy if needed. Many times you may be happy with the merger of acquisition, as it will provide you with a bigger more financially stronger business partner. I'm sure there can be a number of variations where in addition to you having not having liability for termination you could also have them reimburse you for any un-liquidated portions of investments made. In those it would probably require that the change of control posed a real and significant threat to your business.

Where the inclusion of a change of control provision is extremely important is if you are dealing with a company that is venture capital funded where if the if the funder isn’t seeing the growth they want they may want to company to be merged or sold to another. I would also include it in any agreement where I had a long-term firm purchase requirement. I would do that as it would eliminate my having to meet that commitment if they merged with or were acquired by someone that would be a problem. I might also use it as a deterrent to the supplier wanting to merge or a company wanting to acquire them especially if your business volumes represented a significant portion of their business and your termination would significantly impact the worth of the company. Rather that surprising you they could always disclose their intent to you under confidentiality provisions to determine in advance whether it is a problem for you and if not get your advance agreement that you will not exercise the right to terminate for that specific change of control.

Delivery terms versus title transfer

In a post I had another individual tell me that under Ex-Works delivery terms that you would be subject to things like local fees and taxes such as VAT. He recommended using FAS or FCA. Barring anything else in the agreement he would have been right about ex-works. FAS would not automatically avoid those costs as the buyer takes possession of the goods prior to export clearance so technically a sale occurring within that country. FCA should avoid those costs as the seller has the responsibility for export clearance with FCA and usually once something has cleared customs it is treated as an international sale.

Tax and fees are based on the location of sale. INCOTERMS only deals with shipping responsibilities, payments of costs and duties and when the risk of loss transfers. They do not establish where the title transfers, and that can be a completely different location than where you take delivery responsibility and risk of loss. It is the point at which title transfers that creates the sale. The sale is then subject to taxes and fees.

You don’t need to have title to an item to export an item. In fact a supplier may want to retain title until payment is made. This means that if you used EX-Works, if you wanted to avoid those taxes and fees, you would want to specify that title transfer occurs after export customs clearance or even while the item is in transit in "international waters". That makes it an international sale and avoids paying VAT and local country fees that are applied to local sales.

Having the title transfer in a different location is common when you buy an item from a supplier in one country and want to sell it to a customer in another country without actually receiving the item. In that case you don’t want to buy it and take delivery and sell it from the supplier’s country, as you would then be conducting business in that country. If you conduct business there you would need to have a license to operate there. It would make you subject to the laws and taxes of that country. You don’t want to take delivery of it in the customer’s country for exactly the same reasons. There are three options on where you would want to take title.
1. You could take title after customs clearance in the supplier’s country location.
2. You could have title pass on the high seas.
3. You could also have title pass prior to the customs frontier at the port of import such as in a bonded warehouse prior to customs clearance.

You could do a simultaneously sale and transfer of title where the supplier transfers title to you and you transfer title to the customer at any of those locations. You could also acquire title at one location and transfer it at a different location. The main concern of either the Supplier or Customer is to ensure that their risks are covered contractually and with insurance. For example, when you agree to Ex-Works delivery terms you have assume the risk of loss or damage in transit. As further protection the Supplier may want you to also insure the goods for loss. The customer may be concerned with taking title and risk of loss with a delivery term that shifts the risk of loss to them while the item is in-transit, but that can be overcome by insuring the shipment, usually at 110% of the value.