When acquiring a business, often a key component is the contracts to which the company is a party to. Whether they are contracts with customers and the source of a company’s revenue, contracts with service providers or various licensing agreements that allow the company to operate, or a lease for a particularly favourable location or on particularly favourable terms, a company’s contracts are often an important part of a business, adding substantial value. Ensuring the transfer of any such contracts can significantly impact the structure and timing of the acquisition of a business. The following article outlines the rules and exceptions with respect to transferring contracts and the effects of such rules and exceptions in the context of the purchase and sale of a business.
The General Rule and Exceptions
The general rule with respect to contracts is that they are freely assignable. Like other types of property, agreements and the rights under those agreements can be transferred from one party to another. There are, however, exceptions to this general rule. Legislation can restrict the assignability of certain types of contracts, as can public policy (as is the case with agreements dealing with spousal support). Contracts that are personal in nature, involving personal relations or personal skills, are not assignable. An assignment of a contract cannot result in an increase of the burden on the remaining third party to the contract. Finally, contracts may also include anti-assignment provisions, which outright prohibit assignment of the contract, or provide that such assignment can only occur under certain conditions. In the context of most purchase and sale transactions, the relevant exception will be the inclusion in the contracts of anti-assignment provisions; the remainder of this article will focus on such clauses and their implications.
A standard anti-assignment clause, typically referred to as an assignment clause, will prohibit the transfer of a contract without consent. Such a clause will state that the agreement will not be assigned by any party without the prior written consent of the other party. Such a clause may also go on to specify that a party’s consent can or cannot be unreasonably withheld. These provisions are typically included in contracts to ensure that each of the parties have control over who they engage in commercial arrangements and continue to do business with.
The above noted standard assignment clause, however, does not address all forms of business acquisitions. In order to guard against becoming involved with unintended parties through the sale of a company and not just its assets, anti-assignment provisions are often broadened to include language that addresses the transfer of ownership or sale of the shares of a company. This expanded language prohibits the change of control of a party, stating that the sale of the majority of the voting shares of either party to the contract will require the prior written consent of the other party. Sometimes these change of control provisions can deem that a change of control is an assignment for the purposes of the agreement, thereby triggering the same assignment requirements, including whether consent can or cannot be unreasonably withheld.
In an asset purchase transaction, the vendor is the company that owns the assets. The vendor sells some or all of its assets to the purchaser resulting in a transfer of such assets, including those desired contracts to which the company is a party to. Such transfer of the contracts will be done by way of an assignment. The need to obtain consent in the above noted anti-assignment clause would therefore arise in the context of an asset purchase transaction.
In a share purchase transaction, the vendor is the shareholder or shareholders of the target company. The vendor sells the shares to the purchaser, which does not result in any transfer of assets as all assets of the target company, including any desired contracts to which the company is a party to, remain the assets of the target company. In this context, an assignment of a contract is not needed, as the parties to the contract remain the same, only the ownership of one of the parties changes. The need to obtain consent in the above noted anti-assignment clause would not arise in the context of a share purchase transaction, but the need to obtain consent in the change of control clause would arise.
When proceeding with either an asset purchase or a share purchase where the consent of third parties is required, the timing of obtaining such consents must be considered. The contracts themselves may stipulate when consent must be obtained, in some cases requiring several weeks, allowing the remaining party to assess whether they want to provide consent or not. There can also be costs associated with obtaining consents from third parties, as is often the case in leases where landlords will want to review, among other things, the financial strength of the purchaser. Being required to obtain consent of third parties also raises issues with respect to the confidentiality of such a transaction. Either, or both, the vendor and purchaser may want the proposed transaction to be kept confidential from their respective employees, customers, suppliers and competitors. Both parties will also want to consider the impact of any consents not being obtained, especially if such contracts are material to the business. Because of these various issues, it is important to review any contracts that will be transferred or remain with the target company early in the process and discuss how any required consents will be obtained.
To effect an assignment in the context of an asset purchase, the vendor and the purchaser should enter into an assignment agreement whereby the vendor assigns the contract and all rights, obligations and benefits thereunder to the purchaser and the purchaser agrees to assume and perform, as applicable, such rights, obligations and benefits. The contract being assigned may stipulate what the vendor’s obligations will be under the contract after an assignment. In many cases the vendor will not be released of its obligations, regardless of any assignment. In such instances, if the remaining party to the contract is not willing to release the vendor from its obligations, the vendor and purchaser should address each of their obligations in relation to the contract and the third party going forward. Typically, the purchaser agrees with the vendor to be solely responsible and agrees to indemnify the vendor for any non-performance or breach by the purchaser under the contract from and after the date of assignment.
If consent is required from the remaining party to the assignment, such party can either be made a party to the assignment agreement, or their written consent can be obtained prior to entering into the assignment agreement. If consent is not required, contracts can also require that notice of any assignment be given to the remaining party. Regardless of any such provision, notice should be given to the third party that the assignment has occured or will occur. Again, the contract may specify whether such notice needs to be provided prior to the assignment or not.
To effect an assignment in the context of a share purchase, nothing more than the documents effecting the purchase of sale of shares is needed. Depending on the presence and content of any change of control provisions in each contract the company is a party to, notice to or consent of, the third party to each of the contracts may be necessary.
Although generally contracts are assignable, when contemplating the purchase or sale of a business consideration should be given to any contracts that will be assigned or remain with the company being purchased. Each contract should be carefully reviewed in the context of the specific type of transaction being contemplated so as to determine whether any consents or notices will be required before or after completion of the proposed transaction. Specifically, in the context of an asset purchase, only anti-assignment provisions will necessitate obtaining consent, and in the context of a share purchase, only change of control provisions will necessitate obtaining consent. Each party should also have regard to the timing and confidentiality issues that may arise in obtaining any necessary consents. Finally, when effecting the assignment of contracts, consideration must again be given to the type of transaction contemplated as well as provisions detailing any ongoing obligations.