Key Takeaways:
- An Assignment Clause does not necessarily provide M&A veto rights.
- Not all M&A transactions involve an assignment triggering the clause.
- Read your Assignment Clause carefully.
Assignment Clauses
An assignment clause in a contract typically sets forth the conditions under which one party can assign or transfer its contractual rights and obligations to a third party.
To a certain extent, an assignment clause can more accurately be referred to as a “non-assignment” or “anti-assignment” clause.It is usually structured as a general prohibition against assignment or transfer, subject to certain enumerated conditions or exceptions.
Such conditions or exceptions include, for example, transfers to an affiliate of the assigning party. The non-assigning party will understandably want to control who it deals with and may not want to end up with a relationship with an unexpected and unwanted partner, such as a competitor. Therefore, unless any of the express conditions or exceptions for permitted assignment are met, the assignment clause usually requires the written consent of the non-assigning party.
Learn More: Examples of assignment clauses can be found at the Contract Codex (www.contractcodex.com).
Assignment as Part of a Merger
For example, with regard to assignments occurring in connection with a merger or acquisition (“M&A”) event where a party (assignor) is merged into or acquired by a third party (assignee), the parties’ contract usually requires the prior written consent of the other (non-assigning) party. The requirement for such prior consent could be problematic for a target company looking to enter into an M&A transaction. It doesn’t matter if such consent is not to be unreasonably withheld.
Proceeding without such consent could cause the target company to breach its contractual obligations owed to the non-assigning party. Thereby exposing itself to legal (damages) and equitable (injunctive) remedies. In addition, the non-assigning party may have a right to terminate its contractual relationship with the target company. This may happen upon the occurrence of an M&A event to which the non-assigning party did not consent.
In the situation where the non-assigning party is a key supplier or customer of the target company, the termination of the contract could result in significant diminishment of the value of the target company in the eyes of the acquiring company.
As a result, under certain circumstances, the non-assigning party could use the non-assignment clause as a veto right against the proposed M&A transaction. Such a veto right provides the non-assigning party with extraordinary negotiating power vis-à-vis the assigning party. It could allow the non-assigning party to demand and exact extraordinary post hoc concessions from the assigning party. This could be the price for the consent required to proceed with the transaction, including contract amendments that are favorable to the non-assigning party.
Merger Structure Matters
One key consideration driving how a merger or acquisition is structured centers on managing tax consequences. Parties usually favor structures that limit or avoid taxable transactions arising from the M&A event. For example, when an M&A transaction is accomplished via a “reverse-triangular merger” structure, the target company retains its assets (e.g., employees, capital equipment, intellectual property, contracts, etc.). Because no assets are transferred, no taxes are assessed on the value of such assets in connection with the M&A event.
But this structure also provides another important benefit. It avoids triggering the “prior consent” requirement of a typical non-assignment clause. Indeed, under a reverse-triangular merger, contracts of the target company that contain non-assignment clauses do not need the non-assigning party’s consent for transfer. Because the target company is the nominal survivor in the merger and retains its assets and contractual rights and obligations post merger. Because no assignment is made, no consent is required.
Read Your Assignment Clauses Carefully
Surprisingly, many attorneys do not understand the purpose and inherent limitations of a non-assignment clause. Many wrongly consider it to be a general “change-of-control” provision. That gives the non-assigning party a blanket veto right against M&A transactions affecting the target company under any circumstances.
A few years ago, I was representing a company being considered for acquisition by another company. One of the target company’s customers thought we were in violation of our agreement’s change of control clause. Because we did not request or obtain their consent. Here’s the thing–there was no change of control clause. There was a standard non-assignment clause.
I proceeded to explain that we were not required to obtain the customer’s consent to the transaction. Because the transaction was structured to ensure the target company’s survival and retention of all its assets. The only difference was that instead of multiple shareholders, we would now have only one. Everything else would stay the same: same name, same address, we would own all our IP, we would keep all our employees, and we would continue to enforce our rights and discharge our obligations under our contracts with our customers.
After this explanation, our customer’s legal representative never called me again. And the merger transaction closed without any issues.
Now, it is important to remind and caution readers of this article that each assignment clause will be different. You must read it carefully to understand its particular scope. Some assignment clauses may in fact be drafted to give the non-assigning party the kind of change-of-control veto rights imagined by the customer’s attorney in the example above.
Alternatively, a contract may include special rights expressly giving a party substantial control over the other party’s ability to enter into an M&A event. But a typical assignment clause is not one of these special “change-of-control” provisions. And should not be construed as one.
Example Language:
The Contract Codex is a free, online compendium of “exemplars.” Which are legal sections, clauses, and terms culled and curated from hundreds of real commercial contracts. Examples of assignment clauses and related special provisions can be found at the Contract Codex (www.contractcodes.com).
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