“Change your partner?” Beware of Non-Assignment Clauses in Commercial Contracts
“I now pronounce you man and wife.”
Congratulations! You are married.
But what if you woke up one morning and found someone other than your spouse at the breakfast table?
“Who are you?”
“Hi. I am your new spouse. I hope you don’t mind. Your old one decided to move on and appointed me to take over. But don’t worry. I will fulfill all of your former spouse’s marital responsibilities faithfully. And, of course, I am entitled to all of your former spouse’s benefits. We have an appointment with the bank later today to formalize our new joint account. But enough small talk. What’s for breakfast?”
While that scenario is a bit unusual for domestic partners, when it comes to commercial partners — especially commercial partners who are just entering into a business relationship together — there is often a legitimate concern by one — or both — that they avoid waking up one morning to find out that they are in business with someone else.
So how do commercial partners make sure that the party they thought they were going to be doing business with when they signed their contract remains their partner throughout the life of the agreement?
They include in the contract a non-assignment clause.
The basic idea is simple — we entered into this contract because of who you are and what you bring to the table. We don’t want to wake up one morning and find ourselves in business with anyone else but you. Therefore, you are not allowed to transfer your rights or obligations under this contract to anyone else without our consent. If you do, this contract is over and you may have to pay damages as well.
This is simple in concept but watch what happens when the lawyers try to say it. It comes out like this:
“This Agreement and all rights and duties hereunder are personal to Party B and shall not, without the written consent of Party A, be assigned, mortgaged, or otherwise encumbered by Party B or by operation of law. For purposes of this Agreement, the term “assignment” shall, in addition to the transfer of this Agreement or the rights or obligations thereunder, whether voluntarily, involuntarily, by operation of law, or otherwise, be deemed to include (i) a sale or other transfer by Party B of all or substantially all of its assets; (ii) the merger, amalgamation, consolidation, or reorganization of Party B into or with another corporation or other entity as a result of which Party B is not the surviving corporation; or (iii) any transaction (including any of the foregoing transactions, as well as any in which Party B is the surviving corporation) which, whether by way of sale, gift, or other transfer, whether involving Party B or the record or beneficial owners of equity interests in Party B, results in the transfer of more than twenty percent (20%) of the voting control of Party B to a party or parties not a principal of Party B at the time of execution of this Agreement.”
Here are some things to look for when you finally get to the end of the contract where the non-assignment clause is usually hiding.
- Is it mutual or one-way only? Very often a contract that calls itself a “mutual” agreement and starts out talking about both parties doing this or that will suddenly change tone in the assignment clause and become one-sided, as follows: Party A can assign to anyone it wants. Party B cannot assign to anyone without Party A’s permission. Watch out for this.
- Corporate reorganization. Businesses are often organized into parent and subsidiary companies or separate companies with a common owner. Sometimes for business or tax reasons it is a good idea to reorganize the internal corporate structure of a business. Before that happens, you need to check the assignment clause of each contract between any of the companies that is being “reorganized” to make sure that what you are doing is not a breach of that contract. Better yet, when you are negotiating the contract in the first place, try to make sure that you are free to internally organize your business without having to ask permission of any other commercial partner. As long as the reorganization does not result in a different owner or management team, then, in theory, the other side should not care. They are still effectively doing business with the same partner. But some companies can get awfully nitpicky about it.
- Change of control. One step removed from corporate reorganization is a change of control. Whereas it might be true that the outward looking interface between the company and its customers, vendors and commercial partners has not changed, on the inside there is suddenly a new owner of the business. Many companies are understandably nervous about a change in ownership of their commercial partners and so they make sure to include language that will not allow it to happen without their consent. If you are a company that is getting into business with another party specifically because of who owns or controls the business, make sure you include this language to protect you.
- You mean I can’t even sub-contract or sub-license? Well, that depends on what your contract language says. While in theory the job of a non-assignment clause is to prevent you from turning the entire contract over to someone else and moving on, in practice the language will sometimes prevent you from even contracting out part of the job. If you rely heavily on sub-contractors or if your business involves sub-licenses, make sure that the non-assignment clause does not technically trip you up.
- Can I get rid of it altogether? One of the most aggravating experiences for a start-up company that has succeeded and is now on the verge of selling out (or going public) is not being able to close the deal until they get permission from every commercial party with whom they signed a contract containing a restrictive non-assignment clause. This can be a frustrating and time consuming process. If only we had thought of this when we were drafting all of those contracts! Well, you can. You can try for something as simple as this in all of your commercial contracts:
Party B may assign this Agreement and its rights and obligations hereunder in connection with a corporate reorganization, merger or combination, or a sale of all or substantially all of the equity or assets of Party B.
But be careful when the other side says yes, and then the contract comes back looking like this:
Party B may assign this Agreement and its rights and obligations hereunder in connection with a corporate reorganization, merger or combination, or a sale of all or substantially all of the equity or assets of Party B; provided, however, that Party B agrees to remain secondarily liable for the performance of its assignee.
Now you are still on the hook! And, worse, you no longer are in control of what happens. This is not where you want to end up when you are looking to make your big exit.
- Don’t be too nice. Even the most accommodating partners need to set certain limits when it comes to letting the other party assign the contract. For example, under no circumstances should the other party be allowed to assign to a competitor of yours. Or, let’s say you are doing business with the government — the other party should not be allowed to assign to anyone that would cause you to be in breach of specific government regulations such as origin of product or exporting of technology restrictions.
As always, an experienced commercial attorney will be able to recognize the advantages and disadvantages for both parties of an agreement limiting assignability.