Business acquisitions - Non-assignment clause work around: does it work?
Part of a normal due diligence process when making an acquisition of the business (as opposed to the shares) of a target company is to review the material contracts of the target business to see if they contain a non-assignment clause. (If shares are being acquired a similar review is conducted for change of control clauses that would give the counterparty to that contract the right to terminate it once the acquisition of the shares completes.)
Suppliers will often acquiesce readily to the assignment of their contracts, but customers may need more persuading that they will get as good or better service after the deal is done. Either way, the seller will, and the buyer may (particularly if it is quoted), be reluctant to approach suppliers and customers before the deal is signed and announced.
If a non-assignment clause is found in a material contract there are usually only two alternatives:
- do nothing and hope the counterparty will continue trading with the acquired business under a new contract without taking it as an opportunity to renegotiate terms or terminate post change of ownership; or
- seek to have the contract with the counterparty assigned at completion of the acquisition. The approach can be made before execution of the acquisition agreement (with a higher risk to the seller) or after exchange, but as a condition to completion (again with some risk to the seller that the deal collapses and the relationship with the counterparty is affected).
Nothing particularly surprising there, but, unlike in share acquisitions where buyers will generally only focus on the most important contracts, if you are buying assets not shares, all the contracts will need to be assigned to the buyer; and there may be many hundreds of contracts. Clearly, in an ideal world, all contracts where there is a prohibition on assignment to a buyer would be novated (an assignment where the counterparty agrees to the assignment) at completion. In practical terms this will probably only be done with the largest contracts and the others will be left as a post-acquisition matter with both the buyer and the seller using varying degrees of efforts, contractual or otherwise, to ensure it happens.
There is a third option for asset acquisitions, however, and that is to leave any contract that cannot be novated or assigned with the seller: the buyer delivers the service or goods the seller is required to deliver under the non-assigned contract and the seller agrees to collect the payments due and pass them on to the buyer. This has some practical difficulty in that the seller needs to continue to invoice the counterparty and manage the relationship. It can though provide a period in which the counterparty can get used to and test the provision of the services or goods by the new business owner. This form of non-assignment-assignment has been generally accepted to work and now this concept has been tested in the court of appeal.
In the recent case, First Abu Dhabi Bank v BP Oil International, the so-named "equitable assignment" of a contract (where the legal benefit and burden of the contract remains with the seller) was tested and found to work. In this case FADB acquired the right to receive the payments due under a contract for the sale of oil by BPOI to Société Anonyme Marocaine de L’Industrie de Raffinage (SAMIR). SAMIR subsequently failed to pay for the oil and FADB tried to claim that BPOI should repay the money advanced against the receivable. FADB alleged that a clause in the underlying contract between BPOI and SAMIR which limited both parties' ability to assign their respective rights and obligations had the effect that a representation and warranty made by BPOI in the purchase letter with SAMIR, namely that BPOI was not prohibited by any security, loan or other agreement from disposing of the receivable and that such sale did not conflict with any agreement binding on BPOI, was false. The Court of Appeal held (reversing a High Court decision) that BPOI had not breached the warranty as the language in the purchase agreement specifically excluded assignment of the oil purchase contract where such assignment would put BPOI in breach of contract and that the transfer of the benefit of the receivable was valid as the prohibition on assignment could not be construed as preventing the disposal to FADB of any amounts actually received by BPOI from SAMIR or preventing the creation of any trust over the proceeds of the receivable, or further preventing the creation of any rights of subrogation or sub-participation.
This can be a tricky area with commercial and practical implications when buying a business so please get in touch if you would like to talk them through.