Change of control clauses: Keep a grip with sharp clause

In these difficult times it has become relatively common for parties to look closely at the asset bases of their competitors to see what might be of interest to them should they come up for sale, in a distressed state or otherwise. For example, events these past few weeks have underlined that for a facility management company, its value lies in the quality and length of its maintenance contracts and third parties may be keen to acquire them. Contracts will typically be of durations between five and 12 years and in the case of the PFI, up to 25 years.

Although the contracts are likely to provide for potential breaks following price testing and other forms of benchmarking, possession of such a contract is nine-tenths of the law. Employers, however, are keen to ensure that the company they are contracted with remains one that they are happy with. They chose a particular company, and probably a team and an ethos, and they don’t want to see that lost if the company is acquired by others or transfers its interests in the live contracts through assignment or otherwise to an untested third party.

Employers choose a certain company, and probably a team and ethos, to deliver and they don’t want that lost if the company is acquired by others

This is known in legal speak as a contract that involves “delectus personae” - literally translated as “the chosen person”. Such a contract has certain rules implied by law as to the circumstances, if any, in which this contract can change hands. Although these are common law principles (that is, implied at law), a contract will also tend to spell out in clear terms in what circumstances, if any, the employer will allow an assignment of the contract or any of the obligations under it.

This is usually done by a clause restricting the circumstances in which a contractor can assign its obligations to another party. The clause will usually provide that such a transfer requires the consent of the employer unless it is simply for the purposes of some internal company reorganisation or restructuring and the parties behind the company and the contract remain the same.

However, what these assignment clauses don’t do is cover the situation where the contractor’s company on the face of it remains the same but the shareholders have changed - for example, by a third-party share acquisition or management buyout.

Employers and funders will usually look for some say in that scenario. This is done by what is known as a “change of control” clause. This is a clause that allows an employer to treat changes in control of the company as an act of default or grounds for termination of the contract.

It is one of the first clauses a prospective purchaser will look for when carrying out due diligence on a potential company and its contracts. A purchaser will not be as keen to acquire a company whose long-term contracts are all subject to tight change of control clauses. The asset value could, in those circumstances, disappear overnight if the employer uses them as a ground for termination. 

The change of control clause may be widely drafted so that it catches a change in ownership of not just the company to the contract, but also any upstream companies that effectively control the contracting party. 

Alternatively, the changes in ownership that are prohibited or become a ground for default may be restricted to particular categories of company. For example, it may be prohibited for a firm holding a schools contract to become controlled by another involved in alcohol, tobacco, gambling, arms, or any other activity that is incompatible with the education of children.

Change of control provisions are often coupled with an obligation on the contractor to provide notice if a change of control is likely to occur. The employer may then be given the option to consent to the change. If the employer refuses its consent but the change goes ahead anyway, the employer may have the right to terminate the contract.

Right of termination will not be automatic but at the employer’s discretion. It will, however, be a brave company that ignores such risks when acquiring a firm’s assets. This is where reading the small print really pays. Lindy Patterson QC is a partner in Dundas & Wilson